FIN 534 HOMEWORK

FIN 534 HOMEWORK

Assume that you are nearing graduation and that you have applied for a job with a local bank. As part of the bank’s evaluation process, you have been asked to take an examination which covers several financial analysis techniques. The first section of the test addresses discounted cash flow analysis. See how you would do by answering the following questions.

1. Present value of an uneven cash flow stream of -$50, $100, $75, and $50 at the end of years 0 through 3

2.We sometimes need to find how long it will take a sum of money (or anything else) to grow to some specified amount. For example, if a company’s sales are growing at a rate of 20 percent 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)? What is the ear for a nominal rate of 12 percent, compounded semiannually? Compounded quarterly? Compounded monthly? Compounded daily?

5.Suppose on January 1 you deposit $100 in an account that pays a nominal, or quoted, interest rate of 11.33463 percent, with interest added (compounded) daily. How much will you have in your account on October 1, or after 9 months?

Use the following information for 6 and 7:

A firm uses 10-year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent

6.What would be the value of the bond described in part d if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond?

7. What would happen to the bonds’ value if inflation fell, and rd declined to 7 percent? Would we now have a premium or a discount bond?

8.What is the yield to maturity on a 10-year, 9 percent annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that a bond sells 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 yield for the discount bond? (Assume the bond is held to maturity and the company does not default on the bond.)

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