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1. Application of Time Value of Money Skills Gavin Goldenarm has been playing baseball since he was five years old and has always dreamed of playing in the big leagues. Last season, he was a starting pitcher for a double-A (AA)-level baseball team, the Yakima Hops; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 93 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 15-2 win-loss record, an earned run average (ERA) of 2.76, and 123 strikeouts in 99.1 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Gavin received the following email from his agent, Marty Fineprint, indicating that he is being called up to the El Paso Grandies, the Hops's corresponding Major League Baseball (MLB) team. Moreover, Gavin's contract is being revised to reflect his new status. The email describes the general terms and conditions of Gavin's revised contract. Congratulations! You've been called up to the El Paso Grandies. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we'll discuss your options. Congrats again! Salary and Incentives: Gavin Goldenarm hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. Under the league's collective bargaining agreement, the player will receive a Gavin is so excited! According to Marty, the contract is worth $2,858,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Gavin called you to review the terms of the contract and verify Marty's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Gavin have agreed that any funds received could be invested to earn 6.50%, compounded monthly. Congratulations! You've been called up to the El Paso Grandies. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we'll discuss your options. Congrats again! Salary and Incentives: Gavin Goldenarm hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. Under the league's collective bargaining agreement, the Player will receive a Under the league's collective bargaining agreement, the Player will receive a 4% cost-of-living adjustment (COLA) to his annual salary at the beginning of every other year. This means that the player's annual salary will increase at the beginning of year 2 and year 4, as applicable. . In addition, the player will receive a one-time $10,000 time-in-league bonus after six months of participation with an MLB team. This bonus will be paid immediately on completion of the six-month period. The Player is offered a performance-based bonus, as well as a milestone bonus. Both are intended to encourage outstanding performance. The Player is offered the following award-based performance incentive: a 15% bonus if he is selected for consideration of a major award-such as the Cy Young Award (for outstanding pitching). The Player is also offered the following milestone bonus: a $125,000 bonus if he ties Nolan Ryan's 1973 single-season strikeout record (383 strikeouts). The Player is eligible for each potential bonus each year that the contract is in effect and, if expressed as a percentage, will be based on the value of the Player's base annual salary for the corresponding year. If earned, the performance and milestone bonuses will be distributed in a single payment at the beginning of the next contract year. Although this proposal describes only one milestone, the actual contract contains several progressive milestones. Exceeding one milestone creates the opportunity to exceed another. In addition to the proposal offered by the Grandies, I've also been able to secure the following endorsement opportunity: A local car dealer has offered you a contract that will pay $800 per month for two years. This contract is contingent on your accepting the contract with the Grandies and will take effect immediately upon signing your MLB contract. In return for these payments, you will participate in the dealer's promotional events, such as signing autographs and allowing photographs as requested. I've also attached a worksheet that you can use to analyze the deal. I'm in negotiations for the rest of the day, so let's discuss your thoughts on the contract proposal tomorrow. I'm proud of you! Take care, Marty Marty Fineprint Sports Agent, R&R Talent Management Inc. | El Paso Gavin is so excited! According to Marty, the contract is worth $2,858,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Gavin called you to review the terms of the contract and verify Marty's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Gavin have agreed that any funds received could be invested to earn 6.50%, compounded monthly. Contract Evaluation Worksheet Complete the following worksheet by inserting the appropriate values to evaluate the contract and answer the related questions. Note: To clarify possible sources of confusion and simplify your calculations: Assume that all bonuses are earned in each of the years for which they are available and are paid at the end of the corresponding year(s), unless specifically stated differently. Their value should be based on the salary in effect at the time the bonuses were earned. The endorsement proceeds are paid in accordance with the terms of the deal. . Remember that the timing of a cash flow affects the interest rate that is used to discount the cash flow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash flows. Therefore, it may be necessary to compute the appropriate interest rate that should be used in a discounting calculation. Round all dollar amounts to the nearest whole dollar and carry out all interest rate factors to four decimal places. When entering intermediate values as answer choices, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round. Gavin Goldenarm's Contract Evaluation Worksheet A B D E F 1 Assumptions and Calculated Values 2 Bank Rate Information: 3 % Gavin's Bank Account Rate (compounded monthly) Monthly Bank Rate Effective Annual Interest 4 % 5 % Rate 6 7 Salary and Bonus Year 1 Year 2 Year 3 Year 4 Total value Information: 8 $ 9 $ $ S $ 10 Annual Salary (4% COLA) Monthly Salary Discount factor (based on Cell B4 above) Discounted Annual Salary 11.5880 10.8606 10.1789 9.5400 11 12 13 $ IS 14 0.9681 Time-in-League Bonus Discount factor (based on Cell B4 above) Discounted Time-in-League 15 Bonus 16 17 Milestone Bonus S $ $ 18 0.9372 0.8784 0.8233 0.7716 Discount factor (based on Cell B5 above) 19 $ $ $ Discounted Milestone Bonus 20 21 22 0.9372 0.8784 0.8233 0.7716 Performance Bonus Discount factor (based on Cell B5 above) Discounted Performance Bonus 23 $ $ 24 25 $ $ 26 11.5880 10.8606 Monthly Endorsement Contract Payment Discount factor (based on Cell B4 above) Discounted Monthly Endorsement Payment 27 28 29 Contract's Total Nominal Value Contract's Total Discounted Value 30 $ 1. Given your worksheet calculations, which of the following statements is accurate? Is Marty's estimate of the value of Gavin's contract accurate on either a nominal or discounted basis? Check all that apply. It is appropriate and necessary to discount the performance bonus using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments for the performance bonus. It is appropriate and necessary to discount the endorsement contract using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments on the endorsement contract. Marty's estimate of the value of Gavin's contract is incorrect on a nominal basis, and the error is $63,663. Related Question: The local car dealer creating Gavin's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposit $ each quarter, starting exactly two years before the day Gavin signs his contract, to fund her endorsement contract. (Note: The future value interest factor of 6% compounded quarterly for eight quarterly periods is 8.4328.] 1. Bonds and their valuation - Part 1 The value of fixed-income securities: What does it means for the issuer and the investor? One of the most important asset classes for investors are fixed-income securities that consist of debt obligations, or bonds, and preferred stock. In simple terms, a fixed-income security is a financial obligation in which the borrower agrees to pay specified sum of money at specified dates. This transaction involves different groups that comprise the bond markets: issuers, underwriters, and purchasers. A Fee Issuer Underwriter Purchaser B A: B: The entity issuing the debt obligation is the borrower in the transaction. Some of the biggest issuers in the bond market are (1) such as the U.S. government and the government of U.K.; (2) government-related agencies, such as Fannie Mae and Freddie Mac; (2) such as the state of California, Sakai City, Japan; (3) such as British Telecom, and The Walt Disney Co. and (4) such as the European Investment Bank and the World Bank. Why do entities borrow in the form of debt obligations? Economies around the world were still recovering during 2012 after the 2008-2009 recession. Governments and central banks continued their efforts to facilitate economic recovery. The U.S. Federal Reserve Bank (the Fed) kept interest rates at record lows. This, along with several other reasons, found the bond markets flooded with new bond issues. The following article highlights some reasons why firms issued debt obligations to raise funds. In the context of the reasons why entities borrow in the form of bond issues, which statement is correct? Check all that apply. Several bond issues such as general obligation (GO) bonds and revenue bonds-offer federally tax-exempt income that attracts investors seeking tax-free income. When lending money to corporations, banks often include restrictive covenants, such as maintaining a certain level of debt-to-equity ratio at all times. When bonds issued by foreign governments offer higher yields than U.S. Treasury yields, corporate issuers in the United States get the opportunity to issue debt securities at low costs. When government entities need to raise funds to finance projects, they issue debt securities in which investors are the creditors who usually earn a fixed rate of return from the borrower. Corporate-Bond Issuers Race to the Market as U.S. Yields Approach Record Low On April 25, 2011, the Fed announced that short-term interest rates would be kept near zero through late 2014. Because corporate bonds are indexed to Treasury yields and the Treasury yield hit nearly all-time lows, issuing conditions became conducive for investment-grade borrowers. Europe's debt crisis fueled the demand for relatively safer U.S. securities, and the market became more confident that Europe's crisis would not significantly disrupt recovery of the world's largest economy. This triggered issuers to announce investment-grade supply benefiting from the low borrowing costs. Companies such as IBM, Procter & Gamble, Petroleo Brasileiro SA, and Berkshire Hathaway announced more than $15.5 billion debt offerings as yields approached record lows. The spread between the Treasury bonds and investment-grade bonds was hovering at narrow levels, making it attractive for issuers to tap into low borrowing costs. According to a Business Week story, "Yields have fallen to 3.55 percent, the lowest level since touching 3.53 percent on Aug. 10, and within 10 basis points of a record low 3.45 on Aug. 4, according to the Bank of America Merrill Lynch U.S. Corporate Master Index." Another factor contributing to the rising issues of investment-grade bonds was purchasers' eagerness to invest in high-quality securities. Sales of debt offerings had fallen 19% from the year before, and that made investors eager to spend cash on offerings. Sources: Hong, Nicole, Berkshire, P&G Lead Charge of Corporate Bond Issuers. The Wall Street Journal Online, 10 Aug. 2011, ; Catts, Tim, IBM, P&G Plan Bond Sales as U.S. Yields Approach Record Low. BusinessWeek, 1 Feb. 2012, The relationship between corporate bond yields and Treasury yields The article highlights an important relationship between the corporate bond yields and the U.S. Treasury yields. When demand for Treasuries increases, prices rise and yields . All else being equal, this leads to the of corporate bond yields because they are riskier and their yields are than U.S. Treasury yields. However, this does not necessarily imply that particular changes in the Treasury yield will lead to similar changes in the corporate bond yields. A corporate bond with a narrow yield spread and high credit rating will offer a relatively return when the bond is purchased. However, if the yield spread widens, the price of the bond will thus the value of the fixed-income asset class in the investor's portfolio. 1. Application of Time Value of Money Skills Gavin Goldenarm has been playing baseball since he was five years old and has always dreamed of playing in the big leagues. Last season, he was a starting pitcher for a double-A (AA)-level baseball team, the Yakima Hops; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 93 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 15-2 win-loss record, an earned run average (ERA) of 2.76, and 123 strikeouts in 99.1 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Gavin received the following email from his agent, Marty Fineprint, indicating that he is being called up to the El Paso Grandies, the Hops's corresponding Major League Baseball (MLB) team. Moreover, Gavin's contract is being revised to reflect his new status. The email describes the general terms and conditions of Gavin's revised contract. Congratulations! You've been called up to the El Paso Grandies. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we'll discuss your options. Congrats again! Salary and Incentives: Gavin Goldenarm hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. Under the league's collective bargaining agreement, the player will receive a Gavin is so excited! According to Marty, the contract is worth $2,858,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Gavin called you to review the terms of the contract and verify Marty's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Gavin have agreed that any funds received could be invested to earn 6.50%, compounded monthly. Congratulations! You've been called up to the El Paso Grandies. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we'll discuss your options. Congrats again! Salary and Incentives: Gavin Goldenarm hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. Under the league's collective bargaining agreement, the Player will receive a Under the league's collective bargaining agreement, the Player will receive a 4% cost-of-living adjustment (COLA) to his annual salary at the beginning of every other year. This means that the player's annual salary will increase at the beginning of year 2 and year 4, as applicable. . In addition, the player will receive a one-time $10,000 time-in-league bonus after six months of participation with an MLB team. This bonus will be paid immediately on completion of the six-month period. The Player is offered a performance-based bonus, as well as a milestone bonus. Both are intended to encourage outstanding performance. The Player is offered the following award-based performance incentive: a 15% bonus if he is selected for consideration of a major award-such as the Cy Young Award (for outstanding pitching). The Player is also offered the following milestone bonus: a $125,000 bonus if he ties Nolan Ryan's 1973 single-season strikeout record (383 strikeouts). The Player is eligible for each potential bonus each year that the contract is in effect and, if expressed as a percentage, will be based on the value of the Player's base annual salary for the corresponding year. If earned, the performance and milestone bonuses will be distributed in a single payment at the beginning of the next contract year. Although this proposal describes only one milestone, the actual contract contains several progressive milestones. Exceeding one milestone creates the opportunity to exceed another. In addition to the proposal offered by the Grandies, I've also been able to secure the following endorsement opportunity: A local car dealer has offered you a contract that will pay $800 per month for two years. This contract is contingent on your accepting the contract with the Grandies and will take effect immediately upon signing your MLB contract. In return for these payments, you will participate in the dealer's promotional events, such as signing autographs and allowing photographs as requested. I've also attached a worksheet that you can use to analyze the deal. I'm in negotiations for the rest of the day, so let's discuss your thoughts on the contract proposal tomorrow. I'm proud of you! Take care, Marty Marty Fineprint Sports Agent, R&R Talent Management Inc. | El Paso Gavin is so excited! According to Marty, the contract is worth $2,858,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Gavin called you to review the terms of the contract and verify Marty's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Gavin have agreed that any funds received could be invested to earn 6.50%, compounded monthly. Contract Evaluation Worksheet Complete the following worksheet by inserting the appropriate values to evaluate the contract and answer the related questions. Note: To clarify possible sources of confusion and simplify your calculations: Assume that all bonuses are earned in each of the years for which they are available and are paid at the end of the corresponding year(s), unless specifically stated differently. Their value should be based on the salary in effect at the time the bonuses were earned. The endorsement proceeds are paid in accordance with the terms of the deal. . Remember that the timing of a cash flow affects the interest rate that is used to discount the cash flow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash flows. Therefore, it may be necessary to compute the appropriate interest rate that should be used in a discounting calculation. Round all dollar amounts to the nearest whole dollar and carry out all interest rate factors to four decimal places. When entering intermediate values as answer choices, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round. Gavin Goldenarm's Contract Evaluation Worksheet A B D E F 1 Assumptions and Calculated Values 2 Bank Rate Information: 3 % Gavin's Bank Account Rate (compounded monthly) Monthly Bank Rate Effective Annual Interest 4 % 5 % Rate 6 7 Salary and Bonus Year 1 Year 2 Year 3 Year 4 Total value Information: 8 $ 9 $ $ S $ 10 Annual Salary (4% COLA) Monthly Salary Discount factor (based on Cell B4 above) Discounted Annual Salary 11.5880 10.8606 10.1789 9.5400 11 12 13 $ IS 14 0.9681 Time-in-League Bonus Discount factor (based on Cell B4 above) Discounted Time-in-League 15 Bonus 16 17 Milestone Bonus S $ $ 18 0.9372 0.8784 0.8233 0.7716 Discount factor (based on Cell B5 above) 19 $ $ $ Discounted Milestone Bonus 20 21 22 0.9372 0.8784 0.8233 0.7716 Performance Bonus Discount factor (based on Cell B5 above) Discounted Performance Bonus 23 $ $ 24 25 $ $ 26 11.5880 10.8606 Monthly Endorsement Contract Payment Discount factor (based on Cell B4 above) Discounted Monthly Endorsement Payment 27 28 29 Contract's Total Nominal Value Contract's Total Discounted Value 30 $ 1. Given your worksheet calculations, which of the following statements is accurate? Is Marty's estimate of the value of Gavin's contract accurate on either a nominal or discounted basis? Check all that apply. It is appropriate and necessary to discount the performance bonus using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments for the performance bonus. It is appropriate and necessary to discount the endorsement contract using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments on the endorsement contract. Marty's estimate of the value of Gavin's contract is incorrect on a nominal basis, and the error is $63,663. Related Question: The local car dealer creating Gavin's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposit $ each quarter, starting exactly two years before the day Gavin signs his contract, to fund her endorsement contract. (Note: The future value interest factor of 6% compounded quarterly for eight quarterly periods is 8.4328.] 1. Bonds and their valuation - Part 1 The value of fixed-income securities: What does it means for the issuer and the investor? One of the most important asset classes for investors are fixed-income securities that consist of debt obligations, or bonds, and preferred stock. In simple terms, a fixed-income security is a financial obligation in which the borrower agrees to pay specified sum of money at specified dates. This transaction involves different groups that comprise the bond markets: issuers, underwriters, and purchasers. A Fee Issuer Underwriter Purchaser B A: B: The entity issuing the debt obligation is the borrower in the transaction. Some of the biggest issuers in the bond market are (1) such as the U.S. government and the government of U.K.; (2) government-related agencies, such as Fannie Mae and Freddie Mac; (2) such as the state of California, Sakai City, Japan; (3) such as British Telecom, and The Walt Disney Co. and (4) such as the European Investment Bank and the World Bank. Why do entities borrow in the form of debt obligations? Economies around the world were still recovering during 2012 after the 2008-2009 recession. Governments and central banks continued their efforts to facilitate economic recovery. The U.S. Federal Reserve Bank (the Fed) kept interest rates at record lows. This, along with several other reasons, found the bond markets flooded with new bond issues. The following article highlights some reasons why firms issued debt obligations to raise funds. In the context of the reasons why entities borrow in the form of bond issues, which statement is correct? Check all that apply. Several bond issues such as general obligation (GO) bonds and revenue bonds-offer federally tax-exempt income that attracts investors seeking tax-free income. When lending money to corporations, banks often include restrictive covenants, such as maintaining a certain level of debt-to-equity ratio at all times. When bonds issued by foreign governments offer higher yields than U.S. Treasury yields, corporate issuers in the United States get the opportunity to issue debt securities at low costs. When government entities need to raise funds to finance projects, they issue debt securities in which investors are the creditors who usually earn a fixed rate of return from the borrower. Corporate-Bond Issuers Race to the Market as U.S. Yields Approach Record Low On April 25, 2011, the Fed announced that short-term interest rates would be kept near zero through late 2014. Because corporate bonds are indexed to Treasury yields and the Treasury yield hit nearly all-time lows, issuing conditions became conducive for investment-grade borrowers. Europe's debt crisis fueled the demand for relatively safer U.S. securities, and the market became more confident that Europe's crisis would not significantly disrupt recovery of the world's largest economy. This triggered issuers to announce investment-grade supply benefiting from the low borrowing costs. Companies such as IBM, Procter & Gamble, Petroleo Brasileiro SA, and Berkshire Hathaway announced more than $15.5 billion debt offerings as yields approached record lows. The spread between the Treasury bonds and investment-grade bonds was hovering at narrow levels, making it attractive for issuers to tap into low borrowing costs. According to a Business Week story, "Yields have fallen to 3.55 percent, the lowest level since touching 3.53 percent on Aug. 10, and within 10 basis points of a record low 3.45 on Aug. 4, according to the Bank of America Merrill Lynch U.S. Corporate Master Index." Another factor contributing to the rising issues of investment-grade bonds was purchasers' eagerness to invest in high-quality securities. Sales of debt offerings had fallen 19% from the year before, and that made investors eager to spend cash on offerings. Sources: Hong, Nicole, Berkshire, P&G Lead Charge of Corporate Bond Issuers. The Wall Street Journal Online, 10 Aug. 2011, ; Catts, Tim, IBM, P&G Plan Bond Sales as U.S. Yields Approach Record Low. BusinessWeek, 1 Feb. 2012, The relationship between corporate bond yields and Treasury yields The article highlights an important relationship between the corporate bond yields and the U.S. Treasury yields. When demand for Treasuries increases, prices rise and yields . All else being equal, this leads to the of corporate bond yields because they are riskier and their yields are than U.S. Treasury yields. However, this does not necessarily imply that particular changes in the Treasury yield will lead to similar changes in the corporate bond yields. A corporate bond with a narrow yield spread and high credit rating will offer a relatively return when the bond is purchased. However, if the yield spread widens, the price of the bond will thus the value of the fixed-income asset class in the investor's portfolio