Question 3 (7 marks) (This question is from the Week 7 and Week 8 Tutorials) APM Fund Management is considering the following options for their new investment portfolio:

Option 1 - A non-callable corporate bond that pays coupon rate of 9% annually. The bond will be mature in 20 years. The year-to-maturity (YTM) of the bond is 7.5% and the face value of the bond is $1 000.

Option 2 - An ordinary share which just paid a dividend of $7.50 with a constant dividend growth rate of 5% each year. The current market price of this share is $112.50. Option 3 - A $100 par value preference share which pays a fixed dividend of 13%. The required rate of return of the preference shares in the same group is 12%. Required:

a. How much should APM pay for the corporate bond? If the coupon rate is paid semi-annually, how much is the bond value? (4 marks)

b. Calculate the market required rate of return for the ordinary share. Calculate the share value if the market required rate of return is 10%? (2 marks)

c. Compute the value of the preference share and explain why the preference share is considered a hybrid between an equity and a debt instrument? (1 mark)