Accy 510 Handout 4 key

# Accy 510 Handout 4 - Problem 1 Consider the following security issued by Kat Company on the 1st of January 2011 Security(a This security pays

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Problem 1 Consider the following security issued by Kat Company on the 1 of January, 2011: st Security (a) This security pays interest in cash semi-annually on the 30 of June and the 31 of December of th st each year in the amount of 2.5% of face value for each semi-annual payment. This security also pays the full face value of \$1,000 in cash on the 31 of December, 2016. st Assume Peck Inc. purchased security (a) for \$960 when it was issued on the 1 of January, 2011. st Peck classified the investment as a held-to-maturity security investment. Here is the amortization table prepared by Peck at the time of purchase of security (a). Interest Beginning Effective Cash Ending Accrual Asset Payment Interest Interest Amortized Asset Period Balance Date Earned Received Interest Balance 0 \$ 960.00 1 \$ 960.00 6/30/2011 \$ 27.83 \$ 25.00 \$ 2.83 \$ 962.83 2 \$ 962.83 12/31/2011 \$ 27.92 \$ 25.00 \$ 2.92 \$ 965.75 3 \$ 965.75 6/30/2012 \$ 28.00 \$ 25.00 \$ 3.00 \$ 968.75 4 \$ 968.75 12/31/2012 \$ 28.09 \$ 25.00 \$ 3.09 \$ 971.84 5 \$ 971.84 6/30/2013 \$ 28.18 \$ 25.00 \$ 3.18 \$ 975.02 6 \$ 975.02 12/31/2013 \$ 28.27 \$ 25.00 \$ 3.27 \$ 978.29 7 \$ 978.29 6/30/2014 \$ 28.36 \$ 25.00 \$ 3.36 \$ 981.65 8 \$ 981.65 12/31/2014 \$ 28.47 \$ 25.00 \$ 3.47 \$ 985.12 9 \$ 985.12 6/30/2015 \$ 28.56 \$ 25.00 \$ 3.56 \$ 988.68 10 \$ 988.68 12/31/2015 \$ 28.67 \$ 25.00 \$ 3.67 \$ 992.35 11 \$ 992.35 6/30/2016 \$ 28.77 \$ 25.00 \$ 3.77 \$ 996.12 12 \$ 996.12 12/31/2016 \$ 28.88 \$ 25.00 \$ 3.88 \$ 1,000.00 Explain fully how the two different sources of return on the investment for Peck combine to produce the effective rate of return for the security. [This should have been an easy and straightforward question.] The effective rate of return for the security is the total return that Peck will earn over the term of the security. The effective rate of return can be found by dividing the beginning asset balance by the effective interest earned in any period: e.g., \$27.83 / \$960.00 = 2.9% semi-annually, or 5.8% annually. Peck receives returns in part from periodic cash payments of 2.5% semi-annually, or 5% annually, of the \$1,000 principal. The rest of Peck’s return on the investment comes from the capital gain on the bond. Peck lent Kat less than the \$1,000 principal to earn the rest of the 5.8% return over the security’s term. The capital gain of \$40 is treated as interest income to Peck because it’s income from a lending transaction, even though it’s only collected on the maturity date. The combination of return from periodic payments and the appreciation of the investment results in the effective return of 5.8% that Peck earns.

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Now assume James Corp. purchases security (a) from Peck on the 30 of June, 2013, right after
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## This note was uploaded on 02/16/2012 for the course ACCY 510 taught by Professor Staff during the Fall '08 term at University of Illinois, Urbana Champaign.

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Accy 510 Handout 4 - Problem 1 Consider the following security issued by Kat Company on the 1st of January 2011 Security(a This security pays

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