Loan Assignment | Interest Calculation
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Added on 2020-01-23
Loan Assignment | Interest Calculation
Added on 2020-01-23
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(a) If interest and principle are all repaid at the end of the three-month loan term, what is theannual percentage rate on the loan offer make by the bank?On review of case it can be observed that cash rate of Reserve Bank of Australia is 3% perannum. Cash rate is also known as bank rate and it is the rate at which commercial banks borrowmoney from the central bank. It can be observed the case that 1% additional is charged as interestby the commercial bank from the business firm. This means that overall cost of debt for thebusiness firm is 4%.Interest rate on bank loan= Bank rate interest charged by the bank on loan = 3%+1%=4%It can be said that 1% that is charged by the commercial bank from the people is the profitthat is earned on the debt that it give to the people (Cash rate, 2017). Overall, at 4% interest ratedebt is given to the business firm by the bank on yearly basis out of which 3% is related to Bankof Australia and remaining 1% is the rate of interest that is charged as profit by the commercialbank on the customers. (b) ) If the bank were to offer to lower the rate to the Reserve Bank of Australia cash rate ifinterest is discounted, should you accept this alternative?Table 1Interest on different rates with present valuePV@4%PV@2%196000.9615389230.7690.9803929411.765296000.9245568875.740.9611699227.22396000.8889968534.3650.9423229046.29426640.8727685.28InterpretationIt can be seen the table that present value of the interest is 26640 at 4% discount rate. Onother hand, at 2% discount rate present value of interest is 27685. On this basis, it can be saidthat present value of interest is low in case of high discount rate. Money worth more for todaynot tomorrow. If interest rate will be 2% which is below Reserve Bank of Australia then in thatcase in terms of present value one have to pay more to the commercial bank. On other hand, ifthere is high interest rate then in that case there will be low value of interest. Thus, alternative
that is given cannot be accepted. On can make investment in any specific avenue and can earnhuge amount of profit on investment. If we observe and ignore present value method then in thatcase higher amount of interest one have to pay on 4% interest rate. Thus, in order to offset thispoint one can make investment of some proportion of debt in any security like equity and cangood amount of return. Part B(a)Expected return on the portfolio Expected return on the portfolio is 15.80%. This means that it is expected that in theupcoming time period return of 15.80% can be earned on the investment that is made on theportfolio. In order to compute the expected return systematic process is followed and under thisexpected return percentage is multiplied by weight that is related to the specific company. Inother words, it can be said that for computing expected return for the specific stock whichHarvey Norman holding limited in the portfolio its expected return 16% is multiplied to weightwhich is 20%. Same thing is done in case of all other stocks in the portfolio. By adding expectedreturn for all stock portfolio return is computed which is 15.80%. It can be said that sufficientamount of return can be earned on the invested amount in the portfolio. It can be said that for therisk that is taken on the investment sufficient amount of return is generated. It can be seen thatthere are four stocks out of 5 on which there is heavy risk as indicated by higher beta valuewhich is 1 or above.(b) Calculation of portfolio beta In order to compute portfolio beta return on same is multiplied to stock beta. For example inthe table that is given in the appendix it can be observed that expected portfolio return is 15.80%and same is multiplied to the beta value of Harvey Norman holding limited, National Australiabank, Qantas airways limited, Origin energy ltd and BHP Billiton Limited. Computed value isadded and in this way portfolio beta is calculated. It can be observed that portfolio beta value is0.82 which reflects that there is a very heavy risk on the investment that is made on the portfolio.Thus, it can be said that with slight change in the market big variation can be observed in theportfolio return. There is a high beta value of the portfolio because its components beta value isvery high. Hence, one need to follow cautious approach while making investment in theportfolio.
© Security market lineFigure 1Security market lineSecurity market line refers to the chart under which graphical representation of CAPM or capitalasset pricing model is done on the chart. In the chart factors like systematic risk which is alsoknown as market risk is taken to consideration for computing values of CAPM model. In thesecurity market line chart expected return are plotted against the market return and extent towhich specific stock perform well or bad is identified. It can be said that security market line isthe one of the main tool that is used to make stock related decisions (Bollen, Mao and Zeng,2011). It can be observed from the image given above that return of the stocks which are HarveyNorman holding limited, National Australia bank, Qantas airways limited, Origin energy ltd andBHP Billiton Limited is lower than market return. It can be said that stocks are performing belowmarket in terms of return. However, in some stocks gap is reduced between both lines and thismeans that in case of some stocks return nearby to market return can be obtained. (d) Winners and losers in security market lineIt can be seen from the chart given above that there are no winners and all are losers. This isbecause there is no stock in the security market line that is beating the standard market return. Itcan be said that that all stocks are generating return below market which means that there is nowinner in the security marker line.
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