# Two Bond Portfolio

Task 1: a. You own a two-bond portfolio. Each has a par value of $1,000. Bond A matures in five years, has a coupon rate of 8 percent, and has an annual yield to maturity of 9.20 percent. Bond B matures in fifteen years, has a coupon rate of 8 percent and has an annual yield to maturity of 9.20 percent. Both bonds pay interest semi-annually. What is the value of your portfolio? What happens to the value of your portfolio if each yield to maturity rises by one percentage point? b. Rather than own a five-year bond and a fifteen-year bond, suppose you sell both of them and invest in two ten-year bonds. Each has a coupon rate of 8 percent (semi-annual coupons) and has a yield to maturity of 9.20 percent. What is the value of your portfolio? What happens to the value of your portfolio if the yield to maturity on the bonds rises by one percentage point? c. Based upon your answers to (a) and (b), evaluate the price changes between the two portfolios. Were the price changes the same? Why or why not? Task 2: Construct a spreadsheet to replicate the analysis of the table. See below to view the table. That is, assume that $10,000 is invested in a single asset that returns 7 percent annually for twenty-five years and $2,000 is placed in five different investments, earning returns of 100 percent, 0 percent, 5 percent, 10 percent, and 12 percent, respectively, over the twenty-year time frame. For each of the questions below, begin with the original scenario presented in the table: a. Experiment with the return on the fifth asset. How low can the return go and still have the diversified portfolio earn a higher return than the single-asset portfolio? b. What happens to the value of the diversified portfolio if the first two investments are both a total loss? c. Suppose the single-asset portfolio earns a return of 8 percent annually. How does the return of the single-asset portfolio compare to that of the five-asset portfolio? How does it compare if the single-asset portfolio earns a 6 percent annual return? d. Assume that Asset 1 of the diversified portfolio remains a total loss (Â–100% return) and asset two earns no return. Make a table showing how sensitive the portfolio returns are to a 1-percentage-point change in the return of each of the other three assets. That is, how is the diversified portfolioÂ’s value affected if the return on asset three is 4 percent or 6 percent? If the return on asset four is 9 percent or 11 percent? If the return on asset five is 11 percent? 13 percent? How does the total portfolio value change if each of the three assetÂ’s returns are one percentage point lower than in the table? If they are one percentage point higher? e. Using the sensitivity analysis of (c) and (d), explain how the two portfolios differ in their sensitivity to different returns on their assets. What are the implications of this for choosing between a single asset portfolio and a diversified portfolio? PLEASE SEE ATTACHED table below to complete task 2 Diversification Illustration (Invest $10,000 over 25 years) Investment Strategy 1: All funds in one asset Investment Strategy 2: Invest Equally in five different assets Number of assets 1 Number of assets 5 Initial investment $10,000 Amount invested per asset 2000 Number of years 25 Number of years 25 Annual asset return 7% 5 asset returns (annual) Total accumulation at the end of time frame: Total funds $54,274.33 −100% Asset 1 return Asset 2 return 0% Asset 3 return 5% Asset 4 return 10% Asset 5 return 12% Total accumulation at the end of time frame: Asset 1 $0.00 Asset 2 $2,000 Asset 3 $6,772.71 Asset 4 $21,669.41 Asset 5 $34,000.13 Total funds $64,442.25 Task 3: Annual savings from Project X include a reduction of ten clerical employees with annual salaries of $15,000 each, $8,000 from reduced production delays, $12,000 from lost sales due to inventory stock-outs, and $3,000 in reduced utility costs. Project X costs $250,000 and will be depreciated over a five-year period using straight-line depreciation. Incremental expenses of the system include two new operators with annual salaries of $40,000 each and operating expenses of $12,000 per year. The firmsÂ’ tax rate is 34 percent. a. Find Project XÂ’s initial cash outlay. b. Find the projectÂ’s operating cash flows over the five-year period. c. If the projectÂ’s required return is 12 percent, should it be implemented? PLEASE SEE ATTACHED FILE LABELED TASK 3 **must be completed in this file. Submission Requirements: Answer each problem in detail with a conclusion and results. Submit your answer in a Microsoft Excel file, showing step-bystep solutions to all calculations.

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