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Review Set 3
Finance 320 Winter 2011
Thought Questions
1.
An investor is considering two different investments, one issued by Company A
and one issued by Company B.
Both of these investments promise to pay $10,000
in five years.
Assume that market considers that the risk in receiving the
promised payment is the same for both companies.
Further assume that the
investor agrees with the markets assessment concerning the risk of investment
issued by Company A, but that the investor has a strong expectation about an
announcement that Company B is about to make.
The investor strongly believes
that Company B will shortly release a public announcement indicating that it has
negotiated a very satisfactory resolution to a lawsuit that could have forced the
company into bankruptcy.
What should the investor expect to happen to the price
of Company B?
Why?
What market action should the investor take?
What if
the investor held the expectation that the negotiations being conducted by
Company B had ended in failure?
Other Review Questions
1.
Differentiate between lump sum, annuity, perpetuity, and uneven stream.
2.
Differentiate between an annuity due and an ordinary annuity.
3.
In calculating present value of an ordinary annuity or perpetuity with the use of a
financial calculator or formula the same assumption is made about when the first
payment is to occur.
What is that assumption?
For an existing annuity, for how
many days in a year is this answer correct?
What is the assumption made when
using formulas and calculators to calculate present value for an annuity due?
For
an existing annuity, for how many days in a year is this answer correct?
In
general, what adjustment must be made to get the correct answer for the other
days in the year?
Problems to Work
1.
A security makes a single payment of $10,000 in 15 years and six months.
If an
investor feels that the risk is such that this security should pay 9.2% annually,
how much should she pay for this security today?
2.
Barnie, a new GVSU graduate, is considering placing $600 into an investment
fund at the end of each year for the next 30 years.
How much will Barnie have at
the end of this time if his investments earn 8.8% annually?
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View Full Document3.
Barnie decides that he wants to have $2.25 million at the end of 45 years.
If the
interest rate is 8.7%, how much will Barnie have to invest at the
start
of each year
to reach his goal?
4.
Bernadette has invested $17,500 in an account that earns 6% each year.
How
many years will it take before Bernadette has $25,000?
5.
An insurance company promises to pay $25,000 at the first of each year for 10
years.
How much should an investor who determines that the appropriate
discount rate is 7.5% be willing to pay for this stream of payments?
6.
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 Winter '07
 Yatin
 Finance

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