Question
Your friend Jane is interested in purchasing a new financial instrument that is called the Canberra Derivative. This derivative has the following characteristics: The financial
Your friend Jane is interested in purchasing a new financial instrument that is called the Canberra Derivative. This derivative has the following characteristics:
The financial instrument will provide cash flows every four months, with the first cash flow to occur exactly four months from today;
The value of that first cash flow will be $6, and each subsequent cash flow will grow at 3% (hint: the value of the second cash flow will be 3% higher at $6.18, and the value of the third cash flow will be 3% higher at $6.3654 etc);
This financial instrument will continue paying these four-month cash flows indefinitely; and,
The cost of this financial instrument today is $720.
Given the above information, and the knowledge that the required rate of return will be compounded with the same frequency as the cash flows occur, Jane would like you to calculate the annual effective return on this financial instrument. (9 marks)
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