A company has purchased a $1000. 7%, 5-year bond at par that pays interest annually. The discount tractors for he present value $1at 7% for five periods are as followsFor purposes of duration hedging, the duration of the bond is
Answer(s): C
Duration hedging inverse hedging interest-rate ask by matching the duration and value of s assets with the duration and value of habitable. Duration is the weighted average of the times to interest and principal aments. If duration increases, the vitality of the price of the debt instrument increases. Duration is lower if the nominal rate on the instrument is higher because more of the return is received ear1ier. The formula for duration is as follows if Ct is the interest or principal payment, T is the time to the payment, n is the time to aunty, r is the yield to math', and V is the value of the instrumentBecause the expression 1 (1 + )T is the present value of $1, the weighted present values of the payments can be I calculated as follows: $65.45 (1 period x $1 .000 x 7% x .935), $122.22 (2 periods x $1 .000 x 7% x .873), $171.36 (3 periods x $1 .000 x 7% x .816). $213.64 (4 periods x $1,000 x 7% x .763). and $3,814.55 (5 periods x $1,000 x 107% x .713).The total is $4.387.22The value of the bond is $1000 {[$70 x (935 + .873 + .816 + .763 + 713)] + * ($1,000 x .713)). Thus, the duration is approximately 4.39 years ($4,387.22 $1.000)
Essex Corporation is evaluating a lease that takes effect on March 1. The company must make eight equal payments, with the first payment due on March 1. The concept most relevant to the evaluation of the lease is the
Answer(s): A
An annuity is a series of cash flows or other economic benefits occurring at fixed intervals, ordinarily as a result of an investment, Present value is the value at a specified time of an amount or amounts to be paid or received later, discounted at some interest rate. In an annuity due, the payments occur at the beginning, rather than at the end, of the periods. Thus, the present value of an annuity due includes the initial payment at its undiscounted amount. Evaluation of an investment decision. e.g.. a lease, that involves multi-period cash payments (an annuity) requires an adjustment for the time value of money. Because of the interest factor, a dollar today is worth more than a dollar in the future. Consequently, comparison of different investments requires restating their future benefits and costs in terms of present values. This lease should therefore be evaluated using the present value of an annuity due.
Which formula is used to determine the future value that will be available if a given amount of money is invested?
The basic formula used is PV(1 + j)fl = FV i.e., the present value times one plus the interest rate to the nth power equals the future value at the end of the nth time period. When the present amount is known (e.g., A = $100). as well as the interest rate (e.g., i = 10%) and the number of time pentodes (e.g., n = 2). the future value can be calculated as $100(1 + .10)2 $121. A is typical' used in the formula, but it stands (or the PV or FV (whichever is not on the other side of the equals sign).
The discount rate ordinal' used in present value calculations is the
The discount rate most often used in present value calculators is the minimum desired rate of return as set by management. The NPV arrived at in this calculation is a first step in the decision process. It indicates how the project's return compares vent the minimum deseed rate of return
You have just purchased a 15-year, $ 1.000 par value bond. The coupon rate on this bond is 9% annually, with interest being paid each 6 months. If you expect to earn a 12% nominal rate of return on this bond, how much did you pay for it?
Answer(s): B
The cash flows consist of interest of $45 every 6 months for 15 years (30 periods), and $1,000 t the end of the 30th interest period. The 12% discount rate translates to 6% every 6 months. Thus, the calculation is:
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