1. An insurance company is offering a new policy to its customers. Typically, the policy is bought by a parent or grandparent for a child at the childs birth. The details of the policy are as follows: The purchaser (say, the parent) makes the following six payments to the insurance company: First birthday: $800 Second birthday: $800 Third birthday: $800 Fourth birthday: $1,000 Fifth birthday: $1,000 Sixth birthday: $1,000 After the childs 6th birthday, no more payments are made. When the child reaches age 65, he or she receives $1,000,000. If the relevant interest rate is 15% for the first six years and 12% for all subsequent years, is the policy worth buying? Why? (6 marks)
2. Suppose that today you buy an 7% annual coupon bond for $1,100. a) The bond has 15 years to maturity and $1000 face value. What rate of return do you expect to earn on your investment? (2 marks) b) Six years from now, the YTM on your bond has declined by 1.97%, and you decide to sell. What price will your bond sell for? (2 marks)
3. You are running a motor company. Analysts predict that its dividends will grow at 10 percent per year for the next five years. After that, as competition increases, dividend growth is expected to slow to 7 percent per year and continue at that level forever. You company has just paid a dividend of $3 per share. What is the value of this company today if the interest rate is 5 percent? (4 marks)
4. You are thinking of building a new machine that will save you $2,500 in the first year. The machine will then begin to wear out so that the savings decline a t a rate of 5 percent per year forever. What is the present value of the savings if the interest rate is 15 percent per year? (3 marks) 10. If the indirect exchange rate between Euros and U.S. Dollars is 7.4/1, then what is the direct exchange rate between these currencies? (3 marks)