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Finance 1 For IBA - Tutorial 2: Pranav Desai Joren Koëter Lingbo Shen

The document provides examples and problems related to finance topics like present value calculations, interest rates, yield curves, bond prices, and arbitrage opportunities. It asks the reader to calculate interest earned on deposits over different time periods, determine present values and mortgage balances, derive yield curves, and analyze bond prices based on credit ratings. The problems cover a range of foundational finance concepts involving time value of money, interest rates, and fixed income securities.

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Lisanne Ploos van Amstel
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74 views

Finance 1 For IBA - Tutorial 2: Pranav Desai Joren Koëter Lingbo Shen

The document provides examples and problems related to finance topics like present value calculations, interest rates, yield curves, bond prices, and arbitrage opportunities. It asks the reader to calculate interest earned on deposits over different time periods, determine present values and mortgage balances, derive yield curves, and analyze bond prices based on credit ratings. The problems cover a range of foundational finance concepts involving time value of money, interest rates, and fixed income securities.

Uploaded by

Lisanne Ploos van Amstel
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Finance 1 for IBA –

Tutorial 2
P R A N AV D E S A I
JOREN KOËTER
LINGBO SHEN
5.7 Monthly interest rate:
Suppose the interest rate is 6.8% APR
with monthly compounding. What is
the present value of an annuity that
pays $108 every six months for six Effective rate for 6 months:
years?

Present Value:
5.8 Effective rate for 8 months:
You can earn $38 in interest on a
$1000 deposit for eight months. If the
EAR is the same regardless of the
length of the investment, determine Calculating the EAR:
how much interest you will earn on a
$1000 deposit for

a) 9 months.

b) 1 year.

c) 1.6 years.
a)

Generally, it’s possible to convert ANY effective rate to ANY


effective rate without going through the EAR.
5.14 Since the payments are monthly, we need to convert all the
You have decided to refinance your variables to a monthly basis.
mortgage. You plan to borrow
whatever is outstanding on your Time remaining for the mortgage (in months)
current mortgage. The current monthly
payment is $1991 and you have made
every payment on time. The original
term of the mortgage was 30 years, and Monthly rate:
the mortgage is exactly four years and
eight months old. You have just made
your monthly payment. The mortgage
interest rate is 5.537% (APR). How
much do you owe on the mortgage Present value of the mortgage:
today?
5.25
In 1975, interest rates were 7.98% and
the rate of inflation was 12.26% in the The purchasing power of my savings decreased by 3.81%.
United States. What was the real
interest rate in 1975? How would the I have more (nominal) money, but the money can buy less.
purchasing power of your savings have
changed over the year?
5.35 After tax home equity loan:
Your uncle Fred just purchased a new
boat. He brags to you about the low
6.9% interest rate (APR, monthly
compounding) he obtained from the After tax home equity loan is cheaper than the boat loan.
dealer. The rate is even lower than the
rate he could have obtained on his
home equity loan (8.2% APR, monthly
compounding). If his tax rate is 24%
and the interest on the home equity
loan is tax deductible, which loan is
truly cheaper?
5.39 Risky opportunity cost:
In the summer of 1998, at Heathrow Deposit the cash in a UK bank, earn the interest, but be
airport in London, Bestofthebest (BB),
a private company, offered a lottery to exposed to exchange rate risk.
win a Ferrari or 100,000 British
pounds, equivalent at the time to about
$200,000. Both the Ferrari and the
money, in 100-pound notes, were on Riskless opportunity cost:
display. If the U.K. interest rate was
6% per year, and the dollar interest rate Convert the cash to USD, and deposit in a US bank.
was 3% per year (EARs), how much
did it cost the company in dollars each
month to keep the cash on display?
That is, what was the opportunity cost
of keeping it on display rather than in
bank account? (Ignore taxes.)
6.3 ytm
The following table summarizes prices
of various default-free, zero-coupon 6.00%
bonds (expressed as a percentage of
face value): 5.00%

4.00%
a) Compute the yield to maturity for
each bond.
3.00%
b) Plot the zero-coupon yield curve
(for the first five years). 2.00%

c) Is the yield curve upward sloping,


downward sloping, or flat? 1.00%

0.00%
1 2 3 4 5

ytm
6.11
Suppose that Ally Financial Inc. issued
a bond with 10 years until maturity, a
face value of $1000, and a coupon rate a) Two ways:
of 11% (annual payments). The yield
to maturity on this bond when it was
issued was 5%.

a) What was the price of this bond


when it was issued?

b) Assuming the yield to maturity


remains constant, what is the price
of the bond immediately before it
makes its first coupon payment?

c) Assuming the yield to maturity


remains constant, what is the price
of the bond immediately after it
makes its first coupon payment?
6.23 Derive the ytm curve:

Prices of zero-coupon, default-free


securities with face values of $1000
are summarized in the following table:

Suppose you observe that a three-year, Calculate the NA price of 3 year bond with a coupon rate of 10%:
default-free security with an annual
coupon rate of 10% and a face value of
$1000 has a price today of $1183.95. Is
there an arbitrage opportunity? If so, The market price is too low.
show specifically how you would take
advantage of this opportunity. If not, Buy the bond/sell the “synthetic” bond.
why not?

Action
Buy 10 3-year Bonds
Sell 1 1 yr ZC Bond
Sell 1 2 yr ZC Bond
Sell 11 3 yr ZC Bond
Total
6.30 a) Bond Price:
Andrew Industries is contemplating
issuing a 30-year bond with a coupon
rate of 6.87% (annual coupon
payments) and a face value of $1000. b) Bond Price:
Andrew believes it can get a rating of
A from Standard and Poor’s. However,
due to recent financial difficulties at
the company, Standard and Poor’s is
warning that it may downgrade
Andrew Industries bonds to BBB.
Yields on A-rated, long-term bonds are
currently 6.37%, and yields on BBB-
rated bonds are 6.77%.
a) What is the price of the bond if
Andrew maintains the A rating for
the bond issue?
b) What will the price of the bond be
if it is downgraded?

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