Finical modeling Essay Example

6 Analysis

ANALYSIS REPORT

LECTURE’S NAME

Introduction

One of the factors to consider before investing in any kind of investment is the duration to invest. This will also help in determining the amount to be invested. More specifically, in capital markets investment time is a rule of thumb based on the duration of the bonds and mortgages and also the duration applied for financial future markets in hedging against the interest rates volatility which in most cases are used in sensitivity analysis and to help in immunization of the portfolios and the calculation of ratios.

Question one: Yield to maturity

Yield to maturity can be defined as the expected return which the bond holders expect after a given time frame of investing in the bond. In the analysis six different bonds have been analyzed each given different yield to maturity and obvious at different duration of time and rate. From the analysis it can be seen that bonds with the coupon rate < YTM will be priced at a discount; and this can be seen in bond 84RM, 40LV and AE57 both giving price less than the redemption amount hence given at a discount. Furthermore it is clear that bonds with the coupon rate > YTM will be priced at a premium and this is well presented in the bond A2D1 and ALP1 (Homer & Leibowitz 2013). Lastly it can be seen from the example calculation in the excel sheet Q1 that if bonds with the coupon rate = YTM will be priced at the face value. This is very useful for investors who want to invest on bonds and how to price their bonds. It also gives an insight when to buy and sell bonds in the market.

From the calculation analysis, the time duration is clear and time duration in most cases does not influence yield to maturity in its entirety. It must depends on other factors for it to have more impact on the yield to maturity. Assuming other factors constant, it is not true that, bonds with a higher coupon rate have a shorter duration. On the same not it is not true that bonds with a higher YTM have a shorter duration. The yield to maturity depends on many factors and one factor like time may not fully influence the out of bond yield to maturity. However, it is a fact to conclude that bonds with a longer time to maturity have a longer duration

Question two: Mortgage

Mortgage like any other loan in the bank, should not just be taken because of its availability but someone who is pondering on taking the loan should consider many factors. Some of the factors include;

  1. Interest rates

  2. Repayment period

  3. Instalment period among other factors

In this case, we analyzed various loans which are being offered by the Barclays banks which are taking 5 years only. We calculation the interest and amount which are being paid in fourteen instances using equal period and equal loan amount. This was mostly to help in determining the most affordable scenario. From case one to case fourteen, the interest rates differ and by the end of repayment period, all the loan should have been paid without any penalty arising from account balance and without overpayments and at affordable interest rates. The first option with standardized interest rates are more affordable since it allow a complete payment within the lone period hence does not accrue other charges in the process of discounting the mortgage. It further provides a cheaper options enabling the customer to take loans at low interest and affordable installment throughout the period.

The second scenario is of the housing finance cooperation of England where the terms are more flexible with cheaper penalty. In the five scenario calculated, the first option of standardized mortgage loan is much better though with higher interest rates compared with the Barclays banks first scenario.

Question three: Market return

Stock market is a very risky place for investors to invest their money in and there is need for proper sensitivity analysis to help investors to make wise decision and help them to understand the consequences of their decision. Stock volatility can be defines as the measure of the dispersion on the average mean of the return on the security. Standard deviation is one of the ways through which one can measure the volatility of the stock as it tells us on how tightly the price of the stock is grouped around its mean. With smaller standard deviation it implies that the stock price are tightly bunched together while it is wider with larger standard deviation

In our calculation of the two stocks, both HP Inc. stock and TSS stock are tightly bunched together since they have smaller deviation with the later having a more smaller hence having very tight prices. HP has 0.09726159 while TSS has 0.061963 (Hameed, Morck, Shen, and Yeung 2015). Low standard deviation further explains that these two stocks are less volatile hence investors can easily invest in them with less worry. In the portfolio variance both minimum and maximum variance further explains the actual return on the two portfolio stock calculated. In most cases, portfolio variance looks at the standard deviation of each security and how those individual securities correlate with others in the in the market. The relationship is quite clear as the figures shows high relationship of about 39%. This further explain the low volatility but with less return hence risk averse individuals will prefer to have them(Hameed, Morck, Shen, and Yeung 2015).

Question four: Variance analysis

From the analysis we can conclude that with higher VaR losses with higher volatilities, other things being equal and also it is true to state that ceteris paribus higher VaR losses with tighter criteria, other things being equal. This can be shown from the different variance calculation in the excel sheet four.

Bibliography

Hameed, A., Morck, R., Shen, J. and Yeung, B., 2015. Information, analysts, and stock return comovement. Review of Financial Studies, p.hhv042.

Homer, S. and Leibowitz, M.L., 2013. The Concept of Yield to Maturity. Inside the Yield Book: The Classic That Created the Science of Bond Analysis, Third Edition, pp.301-308.