:Answer the following questions.
The country of Daytona, whose currency is the U.S. dollar and the country of Prescott have the same real interest rate of 3 percent. The expected inflation over the next year is 6 percent in Daytona versus 21 percent in Prescott. The one-year currency futures contract on Prescott's currency
is priced at $.30 per pres.
What is the spot rate of the pres assuming interest rate parity holds?
Estimate the expected profit or loss if an investor sold a one-year futures contract today on one million Canadian dollars and settled this contract on the settlement date. Information for the contract is as follows:
PPP exists
Canadian inflation next year expected to be 3 percent
United States inflation next year expected to be 8 percent
Spot rate for Canadian dollar is $0.90
One year futures contract for Canadian dollar is priced at $0.87
New York Co. has agreed to pay 10 million Australian dollars (A$) in two years for equipment that it is importing from Australia. The spot rate of the Australian dollar is $.65. The annualized U.S. interest rate is 4 percent regardless of the debt maturity. The annualized Australian dollar interest rate is 12 percent regardless of the debt maturity. New York plans to hedge its exposure with a forward contract that it will arrange today. Assume that interest rate parity exists.
Determine the amount of U.S. dollars that New York Co. will need in 2 years to make its payment.
. 'Statistically we expect that good decisions will lead to favourable outcomes more often than will either poor decisions, or decisions reached by default.
In a sense, this is a statement of faith on which all Examination questions and answer notes 337 rational approaches to human affairs are based' (Amara and Lipinski).
Discuss this statement, and assess the value of the analytical decision approach as an operational tool of management decision making.
34. The annually compounded discount rate is 5.5%. You are asked to calculate the present value of a 12-year annuity with payments of $50,000 per year. Calculate PV for each of the following cases. (a) The annuity payments arrive at one-year intervals. The first payment arrives one year from now. (b) The first payment arrives in 6 months. Following payments arrive at one-year intervals, at 18 months, 30 months, etc. 35. IRA Accounts and Taxes. An Individual Retirement Account (IRA) allows you to set aside a limited amount of money each year for retirement. These funds will have a special tax status that Fall 2008 Page 7 of 66 depends on several factors. (These factors include your marital status, whether you have other sources of retirement savings, your income, etc.) Suppose that you have $2,000 in pretax income to contribute to the IRA at the end of each year (starting with the end of the current year, i.e., year 1). You will retire in 30 years, and your marginal tax rate will be 28% for all years. Suppose that the account returns a fixed 6% each year until you retire. For simplicity, assume that you withdraw all money at your retirement, and any tax-deferred income is taxed at that time. (a) How much money will you have in year 30 if neither the contribution nor the in- terest income is tax-deferred? (In this case, you can withdraw the money without paying any additional tax at year 30.) (b) How much money will you have in 30 years if the contribution is not tax-deferred but the interest income is? (In this case, only the cumulative interest is taxed at year 30.) (c) How much money will you have in 30 years if both the contribution and the interest income are tax-deferred? (d) Would you expect the benefit of tax deferral to increase or decrease as the tax rate increases? Why?28. Retirement planning: Mr. Jones is contemplating retirement. He is 55 and his net worth now is $2 million. He hopes that after retirement he can maintain a lifestyle that costs him $100,000 per year in today's dollars (i.e., real dollars, inflation adjusted). If he retires, he will invest all his net worth in government bonds that yield a safe annual return of 5%. Inflation is expected to be 2% per year. Ignore taxes. (a) Is Mr. Jones rich enough to retire today if he lives until (i) 80 (ii) 100 (iii) 115? (b) Mr. Jones thinks he will live until about 100. What advice will you give him about retiring? 29. Suppose you invest $50,000 for ten years at a nominal rate of 7.5% per year. If the annual inflation rate is 3% for the next ten years, what is the real value of your investment at the end of ten years? 30. Fill in the blanks. (a) ...% continuously compounded is equivalent to annual interest rate of 12%. (b) 5% continuously compounded is equivalent to annual interest rate of ......%. (c) ......% continuously compounded is equivalent to annual interest rate of 9%. 31. A 10-year U.S. Treasury bond with a face value of $10,000 pays a coupon of 5.5% (2.75% of face value every 6 months). The semi-annually compounded interest rate is 5.2 % (a 6-month discount rate of 5.2/2 = 2.6%). Fall 2008 Page 6 of 66 (a) What is the present value of the bond? (b) Generate a graph or table showing how the bond's present value changes for semi-annually compounded interest rate between 1% and 15%. 32. The Reborn VW Beetle. You are considering the purchase of a new car, the reborn VW Beetle, and you have been offered two different deals from two different dealers. Dealer A offers to sell you the car for $20,000, but allows you to put down $2,000 and pay back $18,000 over 36 months (fixed payment each month) at a rate of 8% compounded monthly. Dealer B offers to sell you the car for $19,500 but requires a down payment of $4,000 with repayment of the remaining $15,500 over 36 months at 10% compounded monthly. Which deal would you choose? (Hint: Find ranges of market interest rates that make one deal more attractive than the other.) 33. Dear Financial Adviser, My spouse and I are each 62 and hope to retire in 3 years. After retirement we will receive $5,000 per month after taxes from our employers pension plans and $1000 per month after taxes from Social Security. Unfortunately our monthly living expenses are $15,000. Our social obligations preclude further economies. We have $1,200,000 invested in a high-grade corporate-bond mutual fund. Unfortu nately the after-tax return on the fund has dropped to 3.5% per year. We plan to make annual withdrawals from the fund to cover the difference between our pension and social security income and our living expenses. How long will the money last? Sincerely, Luxury Challenged Marblehead, MA 34. The annually compounded discount rate is 5.5%. You are asked to calculate the present value of a 12-year annuity with payments of $50,000 per year. Calculate PV for each of the following cases. (a) The annuity payments arrive at one-year intervals. The first payment arrives one year from now. (b) The first payment arrives in 6 months. Following payments arrive at one-year intervals, at 18 months, 30 months, etc.24. Unigene Labs has existing assets that generate an EPS of $5 per year, which is expected to remain constant if the firm does not invest except to maintain exiting assets. Unigene is all-equity financed and its stock has a beta of 1.2. You estimate the market risk premium to be 8% and the risk free rate to be 4. Next year (year 1), the firm has the opportunity to invest $3 per share to launch a new product, which will increase its EPS earnings by $0.80 per year permanently, starting the year after (year 2). The earnings from this product are highly volatile, with an annual standard deviation to be 50% and a correlation to the market to be 0.1. The market's standard deviation is 20%. (a) What is the cost of capital for the company's existing assets? (b) What would be stock price and the price-to-earnings ratio at time zero if the firm did not plan to launch the new product? (c) What is the appropriate discount rate for the new product? Explain your answer. (d) What would be stock price and the price-to-earnings ratio at time zero if the firm did plan to launch the new product? 25. PDQ Corp. is earning EPS of $3.00 next year, 15% of book value per share (BVPS) of $20.00. The companys sales revenues are expanding at 10% per year, and assets and BVPS will grow proportionally. But growth of revenues and assets will drop to 5% per year after year 5. (a) Assume earnings will continue to be 15% of BVPS. What is PDQ stock worth? The cost of capital is 10. (b) Your answer epended in part on a horizon value for the companys shares in year 5. What does that horizon value assume about the NPV of PDQs growth oppor- tunities from year 6 on? 26. Company Us earnings and dividends have been growing at a steady 15% per year. You are confident that the growth will continue for at least one more year, but the growth is not sustainable for the long run. Eventually the companys growth rate will drop below 10%. The current price is $62, and next years dividend is forecasted at $.50 per share. A security analyst forecasts the expected rate of return over the next year as: DIVI 0.50 1 =- Po +9 = 62 + 0.15 = 15.8% Explain why 15.8% is an upward-biased forecast of next years rate of return
