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

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