Principles of Finance
SAMPLE SECOND QUIZ
Do all the problems. Include calculations and/or explanations in your answers wherever appropriate. More credit will be given for correct reasoning than for correct arithmetic.
1. I buy a zero-coupon bond with a face value of $10,000 and a maturity of 20 years.
(a) If I want to make 8% on my money, how much should I pay for the bond? $2,145.48
(b) If I pay $6,139.13 for the bond and hold it until it matures, what rate of return will I have made? 2.47%
- I am planning on investing for retirement. I estimate that I will need $100,000 per year for twenty years. I expect to earn 6%while accumulating and 4% in retirement. . I am now 25 expecting to retire at 67 and have nothing in the plan yet, and from this year I will be contributing equal annual amount.
(a) How big must those contributions be? $7,724
(b) I started on that plan ten years ago and am now 35 and have $80,000 in the plan. If I continue to make the contributions from part (a), what retirement income can I expect? $89,645
- A twenty-year, 5% coupon, $1,000 bond is for sale. It makes annual (once per year) interest payments.
(a) What cash flow can I expect if I buy the bond?
$50, $50, … , $50+$1,000
(b) If its yield to maturity is 7%, what is its price? $788.12
(c) If its price is $1,080.20, what is its yield to maturity? 4.39%
(d) If the bond in part (b) is stripped and the coupon payments sold to one investor while the face value payment is sold to another, what does each pay? $258.42 and $529.70
4. A perpetuity has an original face value of $1,000.00 and original yield of 6%.
(a) What is the promised, annual, coupon payment? $60
(b) If it is priced to yield 5%, what is that price? $1,200.00
(c) If its price is $1,200.00, what is its yield? 5.00%
5. Consider Project A with cash flows:
. A: -$10,000, $3,200, $3,200, $3,200, $3,200
and cost of capital k = 6%.
(a) What are its NPV and IRR? Is it acceptable?
(b) Sketch its NPV profile.
6. Now consider Project B with cash flows:
. B: -$3,000, $2,000, $4,000, $6,000, -$10,000
and cost of capital k = 7%. The spread sheet says that the NPV is -$368 and the IRR is 15%.
(a) Is it acceptable?
(b) The NPV and IRR tests seem to disagree. Explain.
(c) A little computation shows that at k = 44% the NPV is 0. Sketch the NPV profile and explain.