HW3s-S10 - Solution Key to Problem Set 3 ECN 134 Financial...

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Solution Key to Problem Set 3 ECN 134 Financial Economics Prof. Farshid Mojaver Part A: Financial Crisis Part B: Present Value 1. Marjan is shopping for a mortgage to cover a $1,000,000 loan on her house. a. She has been offered a 30 year loan at 8% stated annual interest to be repaid in monthly installments beginning exactly one month after she closes on the house. What will her payments be on this loan? b. She also found a 15 year loan at 7.5% stated annual interest to be repaid in monthly installments beginning exactly one month after she closes on the house. What will her payments be on this loan? c. What are Marjan’s total payments on the 30 year $1,000,000 loan? What are her total payments on the 15 year $1,000,000 loan? Answer) (a) ( 29 + - = mT m r m r C PV / 1 1 1 / or PV = C.A, where ( 29 + - = mT mT r m r m r A / 1 1 1 / 1 then ) / 1 ( mT r A PV C = ( 29 65 . 337 , 7 $ 000 , 000 , 1 08 . 0 12 12 08 . 0 1 1 1 1 360 = = + - = - mT r mT r A C thus A (b) 12 . 270 , 9 $ 12 075 . 0 1 1 1 12 075 . 0 ) 000 , 000 , 1 ( 1 180 = + - × = - C (c) 30- year loan: Total paid=7,337.65 × 360=$2,641,554 15-year loan: Total paid=9,270.12 × 180=$1,668,612.60 (But actually, this calculation is not meaningful in finance because it does not consider discount factor for the future payment.) 2. Bahram’s Bonds assembles mortgage bonds into portfolios and sells shares (trenches) based on when the underlying mortgage are paid off. The company plans to issue stock that promises profits per share of $100 next year, growing at 6% per year indefinitely. Profits will be distributed annually. The market discount rate for assets of comparable risk is 12%. What is the present value of the income stream associated with a share of Bahram’s Bonds?
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Answer) 67 . 1666 $ 06 . 0 12 . 0 100 = - = - = g r C PV 3. Young Joon is considering the purchase of a troubled econometric consulting company. He thinks he can resurrect it if he puts $100,000 per year in at the end of each of the first 5 years. He plans to sell it for $1,000,000 at the end of the sixth year. The market interest rate for loans of comparable risk is 11%, which is the same as Young Joon’s discount rate for this property. a.
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This note was uploaded on 06/05/2010 for the course ECN 60277 taught by Professor Farshidmojaver during the Spring '10 term at UC Davis.

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HW3s-S10 - Solution Key to Problem Set 3 ECN 134 Financial...

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