Answer To: Would like the same nerd that handled assignment XXXXXXXXXXIt is the same concept. P6-8, P6-14,...
Shakeel answered on Jan 30 2021
P6-8
P6–8 Term structure A 1-year Treasury bill currently offers a 5% rate of return. A 2-year Treasury note offers a 5.5% rate of return. Under the expectations theory, what rate of return do investors expect a 1-year Treasury bill to pay next year?
rate of return on 1 year treasury bill, r1 = 5% = 0.05
rate of return on 2 year treasury bill, r2 = 5.5% = 0.055
rate of return do investors expect a 1-year Treasury bill to pay next year = ((1+r2)2/(1+r1))-1 = ((1.055)2/(1.05))-1 = 0.060024 6.00% ( after rounding off)
Rate of return on 1-year T bill 5%
Rate of return on 2-year T bill 5.50%
Therefore,
Rate of return to investors in next year 6.00%
P6-14
P6–14 Asset valuation and risk Laura Drake wishes to estimate the value of an asset expected to provide cash inflows of $3,000 per year for each of the next 4 years and $15,000 in 5 years. Her research indicates that she must earn 4% on low-risk assets, 7% on average-risk assets, and 14% on high-risk assets.
a. Determine what is the most Laura should pay for the asset if it is classified as (1) low-risk, (2) average-risk, and (3) high-risk.
b. Suppose that Laura is unable to assess the risk of the asset and wants to be certain she’s making a good deal. On the basis of your findings in part a, what is the most she should pay? Why?
c. All else being the same, what effect does increasing risk have on the value of an asset? Explain your answer in light of your findings in part a.
A Year Cash inflow PVIF@4% PV of cash flow
Calculate the value of the asset should Laura pay, if it is at low-risk: 1 $3,000 0.9615 $2,884.62
Value of asset at low risk – the required rate of interest is 4%. 2 $3,000 0.9246 $2,773.67
V0= CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3+ CF4/(1+r)4+ CF5/(1+r)5 3 $3,000 0.8890 $2,666.99
= $3,000/(1.04)1 + $3,000/(1.04)2 + $3,000/(1.04)3 + $3,000/(1.04)4+ $15,000/(1.04)5 4 $3,000 0.8548 $2,564.41
= $3,000/1.04+ $3,000/1.08+ $3,000/1.12+ $3,000/1.16 + $15,000/1.21 5 $15,000 0.8219 $12,328.91
= $2,884.61 + $2,777.77 + $2,678.57 + $2,586.20 + $12,396.69 Sum $23,218.59
Therefore, the amount Laura should pay for the low-risk asset is $23,323.84
Therefore, the amount Laura should pay for the low-risk asset is $23,218.59
B
Calculate the value of asset should Laura pay, if it is at average-risk: Year Cash inflow PVIF@7% PV of cash flow
Value of asset at low risk – the required rate of interest is 7%. 1 $3,000 0.9346 $2,803.74
V0= CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3+ CF4/(1+r)4+ CF5/(1+r)5 2 $3,000 0.8734 $2,620.32
= $3,000/(1.07)1 + $3,000/(1.07)2 + $3,000/(1.07)3 + $3,000/(1.07)4+ $15,000/(1.07)5 3 $3,000 0.8163 $2,448.89
= $3,000/1.07+ $3,000/1.14+ $3,000/1.22+ $3,000/1.31+ $15,000/1.40 4 $3,000 0.7629 $2,288.69
= $2,803.73 + $2,631.57+ $2,459.01 + $2,290.07 + $10,714.28 5 $15,000 0.7130 $10,694.79
Therefore, the amount Laura should pay for the average-risk asset is $20,898.66 Sum $20,856.43
Therefore, the amount Laura should pay for the average-risk asset is $20,856.43
C
Calculate the value of asset should Laura pay, if it is at high-risk: Year Cash inflow PVIF@14% PV of cash flow
Value of asset at low risk – the required rate of interest is 14%. 1 $3,000 0.8772 $2,631.58
V0= CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3+ CF4/(1+r)4+ CF5/(1+r)5 2 $3,000 0.7695 $2,308.40
= $3,000/(1.14)1 + $3,000/(1.14)2 + $3,000/(1.14)3 + $3,000/(1.14)4+ $15,000/(1.14)5 3 $3,000 0.6750 $2,024.91
= $3,000/1.14+ $3,000/1.29+ $3,000/1.48+ $3,000/1.68+ $15,000/1.92 4 $3,000 0.5921 $1,776.24
= $2,631.57 + $2,325.58 + $2,027.02 + $1,785.71 + $7,812.50 5 $15,000 0.5194 $7,790.53
Therefore, the amount Laura should pay for the high-risk asset is $16,582.38 Sum $16,531.67
Therefore, the amount Laura should pay for the high-risk asset is $16,582.38
P6-23
P6–23 Bond valuation and yield to maturity Mark Goldsmith’s broker has shown him two bonds issued by different companies. Each has a maturity of 5 years, a par value of $1,000, and a yield to maturity of 7.5%. The first bond is issued by Crabbe Waste Disposal Corporation and has a coupon rate of 6.324% paid annually. The second bond, issued by Malfoy Enterprises, has a coupon rate of 8.8% paid annually.
a. Calculate the selling price for each bond.
b. Mark has $20,000 to invest. If he wants to invest only in bonds issued by Crabbe Waste Disposal, how many of those bonds could he buy? What if he wants to invest only in bonds issued by Malfoy Enterprises? Round your answers to the nearest integer.
c. What is the total interest income that Mark...