Financial Management

FINANCIAL MANAGEMENT
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Question 1
a) Product Ace provides an annual return of 5% p.a. If there is no recession during the five
years, the annual returns from 6th year onwards would be 7% p.a. for a period of ten years.
Hence, amount expected at the end of 15 years = 8000*1.055*1.0710 = $20,085.11
b) Product Ace provides an annual return of 5% p.a. If there is no recession during the five
years, the annual returns from 6th year onwards would be 3% p.a. for a period of ten years.
Hence, amount expected at the end of 15 years = 8000*1.055*1.0310 = $13,721.73
c) The relevant formula for the future value of annuity due is stated below.
Here, P = $ 800, r=5 percent, n = 10
Therefore, FV of annuity = (1.05)*800*[(1.0510-1)/0.05] = $10,545.63
The above amount would keep on increasing for the next 10 years at 5 percent per annum.
Hence, amount at the end of 20 years = $10,545.63 * 1.0510 = $17,209.97
d) Deposit rate = 2 percent per annum compounded daily
Effective interest rate = (1 + (2/36500))365 -1 = 2.02% p.a.
Lending rate =6% per annum compounded monthly

Effective interest rate = (1+ (6/1200))12-1 = 6.17% p.a.
e) In order to compute the payoff from the two investment options, it is imperative to compare
the expected values at the end of 15 years.
It is known that is a 70% chance of recession and 30% chances of recession not happening.
Hence, expected value from Product Ace = 20085.11*0.3 + 13721.73*0.7 = $15,630.74
This needs to compared with the maturity value of Project Bee after 15 years
Expected value from Product Bee after 15 years = $10,545.63 * 1.055 = $13,484.46
By comparing the expected values from the above two investment options after 15 years, it is
apparent that Product Ace presents a superior investment option.
Relevant assumptions include the following.
1) The rate of returns in the two investment options remain constant and do not alter.
2) It is possible to end project Bee after 15 years.
Question 2
a) With regards to payment of coupon , the following computation is relevant.
Face value = $ 1000
Coupon rate = 6% paid semi annually
Hence, coupon paid per bond after six months = (0.06/2)*1000 = $30
Total coupon payment every six months on the total issue = 30*50,000 =$ 1,500,000
The YTM three years ago should have been the discount rate for which the future cash flows
from the bond would lead to be price of the bond.