Question

8. You buy a 30 year zero coupon bond which will pay you  in 30 years at an annual yield of  compounded once per year. A few minutes later the annual yield rises to  compounded once per year. What is the percent change in the value of the bond?

(Hint: recall the formula for percent change. The answer should be negative.)

10. You are offered an annuity that will pay you  once per year, at the end of the year, for  years. The first payment will arrive one year from now. The last payment will arrive twenty five years from now. Suppose your annual discount rate is , how much are you willing to pay for this annuity?(hint: this is the same as the present value of an annuity.)

11. An investment gives you a 18.35% nominal return over 1 year. There was 2.5% inflation over that year. What was your exact real return? (Don’t use the Fisher Equation.)

12. An investment gives you an 8.35% nominal return over 1 year. There was 1.5% inflation over that year. According to the Fisher Equation what was your real return?

13. You would like to develop an office building. Your analysts forecast that it will cost you  immediately (time 0), and it will cost you  in one year (time 1). They forecast you can sell the building for  in two years (time 2). If your discount rate is , what is the net present value of this investment?

14. You would like to develop an office building. Your analysts forecast that it will cost you  immediately (time 0), and it will cost you  in one year (time 1). They forecast you can sell the building for  in two years (time 2). If your discount rate is , what is the internal rate of return for this investment?

15. You would like to develop an office building. Your analysts forecast that it will cost you  immediately (time 0), and it will cost you  in one year (time 1). They forecast you can sell the building for  in two years (time 2). If your discount rate is  should you invest in this building? Write 0 for no, and write 1 for yes.

Answer 1

11) (1+nominal rate) = (1+real rate) * (1+ Inflation rate)

= (1+0.1835) = (1+RR) (1+0.025)

(1+RR) = 1.1835/1.025 = 1.1546

RR = 0.1546 (or) 15.46%

12) as per FISHER Equation -- nominal rate = real rate + inflation rate

8.35% = RR + 1.5%

Real rate = 6.85%

13) year cash flow PVF @ discount rate discounted cash flow

(1) (2) 3=1*2

  0 initial outflow

1 outflow

2 sales

add the product

sum is net present value and if it is positive invest and at IRR discounted cash inflow is equal to discounted cash outflow