Your parents have come to you for financial advice because you have told them about this incredible finance course you are taking and they are paying for. Your parents have been offered an investment that will pay $100 per year forever and the first cash flow will occur 11 years from today. If interest rates are expected to be 6.125% forever.

a. what is this investment worth today? HINT: be sure to include a time line in your explanation to your parents. Show your work and explain your answer. (4 marks)

	Perpetuity
	Cash Payment Amount	$ 100
	Interest Rate (yield)	6.125%
	Present Value	$ 1,632.65

a

b. Your parents have been offered another investment that will pay $90 per year forever and the first cash flow will occur 11 years from today; however, the cash flow amounts are expected to grow at 1% forever. If interest rates are expected to be 6.125% forever, what is this investment worth today? HINT: be sure to include a time line in your explanation to your parents. Show your work, time line and explain your answer. (4 marks)

Problem 2 (10 marks)

You have been very successful in business and it is time to buy the big boat so you can sail the blue seas of the Bedford basin and entertain your friends. You do your research and find the boat you want in Portugal. The price of the boat is $300,000 and it will cost $20,000 to have the boat delivered to Halifax. You go to the bank to borrow the entire amount of the purchase and the bank offers you a loan with a 20 year amortization at 5% with a 5 year term. You plan on making monthly payment on this loan.

1. Calculate your monthly payments. (3 marks)

b. At the end of the 5^th year, you will need to negotiate a new interest rate and a new payment schedule. The loan contract allows you to pay down 10 percent of the original loan amount with no penalty. You have saved the 10 percent so you will pay down the amount you owe to the bank. How much do you still owe the bank? (2 marks)

c. When you go to the bank to re-negotiate your loan with the bank. Interest rates are now 4.75 percent. If you make the payment to reduce the loan balance for the remaining amortization period, what are your new loan payments? (3 marks)

d. If this loan had been to the purchase of a summer home, what changes would be made for your calculations in the previous parts of this question? (2 marks)

Chapter 7 Interest Rates and Bond Valuation

Question 3 (8 marks)

A company is contemplating a long term bond issue. It is debating whether or not to include a call provision. What are the benefits to the company from including a call provision? What are the costs? How do these answers change for a put provision?

Question 4 (4 marks)

How does a bond issuer decide on the appropriate coupon rate to set on its bonds? (2 marks) Explain the difference between the coupon rate and the required rate of return. ? (2 marks)

Question 5 (10 marks)

Bond P is a 12 percent coupon bond that is selling at a premium. Bond D is a 6 percent coupon bond currently selling at a discount. Both bonds make annual payments and have a YTM of 9 percent and have 5 years to maturity.

a. What is the current yield for bond P? (2 marks)

b. What is the current yield for bond D? (2 marks)

c. If interest rates remain unchanged, what is the expected capital gains yield over the next year for bond P? (2 marks)

d. If interest rates remain unchanged, what is the expected capital gains yield over the next year for bond D? (2 marks)

e. Explain your answers and the interrelationships among the YTM, the coupon rate and the capital gains yield. (2 marks)

Question 6 (3 marks)

Any regular coupon bond of any maturity will sell for its face value if the coupon rate is the same as the market rate of interest. TRUE or FALSE? Explain and provide an example to support your answer.

Problem 7. (9 marks)

Three years ago, you purchased a 30 year, $1,000 par value bond for a quoted price of 95.0. The bond pays its 5% coupon semi-annually.

1. If the present market rate on identical bonds is 4%, at what price should the bond trade today? (3 marks)

2. If you sell your bond today for the price you calculated above, what is your EFFECTIVE ANNUAL HOLDING PERIOD RETURN over the 3-year period? (6 marks)