FSTI Holdings has 4 major investments in its portfolio, and you have been asked to determine their current market value. Its holdings are as follows
1. It purchased an annuity from Best Financial 5 years ago. At that time, it paid a lump-sum of $10 million, and in return, FSTI was promised a monthly payment of $100,000, for a total of 15 years from date of purchase.
Note: For this annuity, like most financial products, payments are paid/received at the end of the period (“payment in arrears”). In that case, the “Type” field in the Excel formula has a value of 0, or can be left blank.
2. It owns 250,000 shares of Cornwall Systems, for which it paid $15 per share in 2003. Cornwall’s dividend has been growing at a steady rate of 2.8% per year. Given the somewhat risky nature of the company’s business model, the market’s required return on its shares is 8.5%.
3. Last week, it bought $50 million (par value) of newly issued 10-year U.S. Government Treasury Notes. They were purchased at par (i.e., exactly the principal amount), and have a 1.7% coupon rate, paid annually. (Hint: Bonds only trade at par when the coupon rate is exactly equal to its required return.)
4. Two years ago, it entered into a 7-year interest-rate swap agreement, with a $25 million notional amount, under which it pays Morgan Trust a fixed rate of 4.2%, and receives 3-month LIBOR. Payments are made quarterly.
Calculate the current value of each of these holdings, using the following assumptions.
1. FSTI was just offered a new 10-year, $50 million annuity from Best Financial, paying $506,225.75 per month. (Hint: Use the terms of this offer to calculate the current market rate.)
2. Cornwall Systems has recently gone private, and thus does not have a quoted market price per share. However, it continues to pay dividends regularly, and its most recent dividend was $1.70, and is still expected to grow at 2.8% per year. However, as a privately-held company, an additional liquidity premium of 1.5% needs to be added to its required return.
3. The Consumer Price Index report issued this morning suggests that inflation will be 0.1% lower than the market had been previously expected. 10-year Treasury Notes are now trading with a yield of 1.65%.
4. 5-year interest rate swaps are now being quoted at 3.2% (pay fixed, receive 3-month LIBOR; payments made quarterly), and 7-year interest rate swaps at 3.8% (pay fixed, receive 3-month LIBOR; payments made quarterly). (Hint: Calculate the dollar-amount of contractual fixed payments to Morgan Trust under the swap agreement.)
Note: Assume the floating-rate portion is exactly at market, i.e., no gain or loss in value, and will continue to be regardless of market changes. Thus, only the fixed-rate portion is subject to price change.