Question

An investor considers investing 100 000 TL for the next year. This investor has 3 options. The first option is to buy a government bond that sells 100 TL. The par value of this government bond is also 100 TL and the remaining maturity is 1 year. This government bond pays %20 annual coupon interest. The second option is to buy a commercial paper which sells 2200 TL discount. The par value is 10 000 TL and the maturity is 1 year. The other alternative is to invest in a common stock for a year. The current market price of the common stock is 6 TL per share and 1-year target price estimation of the market analysts is 7.90 TL on average for this share. Which option would you invest in and why? Show your answer mathematically.

Answer 1

As the Government bond is selling at par value (TL 100), the YTM of the bond is the same as its coupon rate i.e. the return from Investing in the bond will be 20%

The Commercial Paper is available at TL 10000 - TL 2200 = TL 7800

and the maturity amount is TL 10000

So, Return on Commercial Paper =2200/7800 = 28.21%

Return on Share = (7.9-6)/6 = 31.67%

From the available options , highest return is promised by the share and so Shares must be chosen (ignoring the riskiness of options)