Mid-TermAnswers - Course Financial Management Term III...

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Course: Financial Management Term: III Section A Attempt all questions Each question carries 6 marks [5 x 6 =30] 1. You have to pay $12,000 a year in school fees at the end of each of the next six years. If the interest rate is 8%, how much do you need to set aside today to cover these bills? [3] Answer: Find out the PV of $ 12,000 as 6 years annuity. Answer – $ Rs 55476 You have invested $60,476 at 8%. After paying the above school fees, how much would remain at the end of the six years? [3] Answer: $ 60,476 and $ 55476 are at the same point of time and hence law of subtraction applies Difference is $ 5,000. Find out the FV of $ 5000 after 6 years. Answer - $ 7934.37 2. Jill has $40,000 on hand and expects her income next year to be $48,000. She would like to consume $50,000 today by borrowing the additional $10,000 from a bank at the market rate of 20%. A friend, however, suggests that she should instead borrow $15,000 from the bank and invest the additional $5,000 in an investment project that will return $12,000 in one year. The friend believes that this will make Jill better off. What should Jill do? Answer: If Jill borrows $10,000 at 20 % to satisfy her consumption plan, then next year she will pay back $12,000 (=$10,000 × 1.20) and have $36,000 (=$48,000 - $12,000) to consume. On the other hand, if she follows her friend's advise and borrows $15,000 and invests $5,000 in the project, then next year she will pay back $18,000 (=$15,000×1.20) and will be able to consume $42,000 (=$48,000 + $12,000 - $18,000). Thus, by investing in the project Jill can consume the same today and an additional $6,000 next year. 3. A 10 year, 12 % semiannual coupon bond, with a par value of Rs 1,000 may be called in 4 years at a call price of Rs 1,060. The bond sells for Rs 1,100 (Assume that the bond has just been issued) a) What is the bond’s approx YTM ? [2] b) What is the bond’s current yield? [1] c) What is the bond’s capital gain or loss yield? [1] d) What is the bond’s approx yield to call? [2] 1 | P a g e
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Answer: a) + + = 3 2P M n P - M C YTM Approx to get AYTM = 10.31% b) Current Yield = C / P = 120/1100 = 10.91%. Or find out semiannual current yield by using C = 60 and later multiplying the rate by 2 to make it annual. c) Capital Gain/Loss Yield = YTM – Current Yield = 10.31% - 10.91% = (0.79%) Loss. Capital gain or loss yield should also be always reported on annual form. d) + + = 3 2P price Call n P - Price Call C YTC Approx = 10.12% Alternatively, you can find YTM by using semiannual data, C = 60, n = 20 and then report the answer in annual form by multiplying the semiannual YTM by 2. Same can be done in case of YTC using C= 60, n = 8 and them multiplying the rate by 2 to make it annual percentage rate.
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This note was uploaded on 09/04/2011 for the course FIN 3030 taught by Professor Houston during the Spring '11 term at Southeaster Oklahoma State University.

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Mid-TermAnswers - Course Financial Management Term III...

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