FIN 534 Homework Set 2 A Graded
Solution
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Use the following information for
Questions 1 through 5:
Assume that you are nearing
graduation and have applied for a
job with a local bank. The bank’s
evaluation process requires you to
take an examination that covers several financial analysis techniques.
The first section of the test asks
you to address these discounted cash flow analy
sis problems:
1.
What is the present value of the fol
lowing uneven cash flow stream
−
$50, $100, $75, and $50 at the
end of Years 0 through 3
?
The appropriate interest rate is
10%, compounded annually
.
2.
We sometimes need to find out how l
ong it will take a sum of money (or
something else, such as
earnings, population, or prices) to
grow to some specified amount.
For example, if a company’s sales
are growing at a rate of 20% per
year, how long will it take sales to double?
3.
Will
the future value be larger or
smaller if we compound an initial amount more often than annually
—
for example, every 6 months, or
semiannually
—
holding the stated interest rate
constant? Why?
4.
What is the effective annual rate
(EAR or EFF%)
for a nomi
nal rate of 12%, compounded
semiannually? Compounded quarterly?
Compounded monthly? Compounded daily?
5.
Suppose that on January 1 you
deposit $100 in an account that pays a
nominal (or quoted) interest
rate of 11.33463%, with interest
added (compounded) daily. How much will you have in your account
on October 1, or 9 months later?
Use the following information f
or Questions 6
and 7
:
A firm issues a 10
–
year, $1,000
par value bond with a 10% annual
coupon and a required rate of return is
10%
.
6.
What would be the value of the bond
described above if, just after it had been issued, the expected
inflation rate rose by 3 percentage
points, causing investors to require a 13
% return? Would we now
have a discount or a premium bond?
7.
What would happen to the bond’s
value if inflation fell and rd declined to 7%? Would we now have a
premium or a discount bond?
8.
What is the yield to ma
turity on a 10
–
year, 9% annual coupon, $1,000 par
value bond that sells for
$887.00? That sells for $1,134.20?
What does a bond sell
ing
at
a discount or at a premium tell
you
about the relationship between rd
and the bond’s coupon rate?
9.
What are the total return, the
current yield, and the capital gains y
ield for the discount bond
in
Question #8 at $887
.00
?
At $1,134.20?
(Assume the bond is held to maturity
and the company does
not default on the bond.)
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