Compound

1
Compound Prosper

• GEK2507

Frederick H. Willeboordse frederik_at_chaos.nus.edu.s
g
2
Exercises for Test 2
Answers
3
Important note The sample questions provided
here are for your reference only. The questions
asked during the test will be similar in style
but can be very different otherwise. For this
test, most of the points will go to the long
final question which is pretty tough!
4

• Over any thirty year holding period, which had
  the worst recorded performance bonds or stocks?

Bonds

• When interest rates go up, does the market-value
  of a bond go up or down?

Down

• Assume that you have 2400.- in cash at the
  beginning of 2003 and that inflation is expected
  to run at the rates indicated to the right.
• In todays dollars, how much is your money worth
  at the end of 2005?

2400 5/6 2000 2000 4/5 1600 1600 3/4
1200
5

• Let us assume you invest in a stock on Jan 1,
  1990 that pays 3 dividend a year (to all
  shareholders who own stock on the 31st of the
  previous year) and that has the following share
  prices
• Jan 1, 1990 12.3Jan 1, 1991 14.3Jan 1,
  1992 13.9Jan 1, 1993 15.2Jan 1, 1994
  12.8Jan 1, 1995 16.3Jan 1, 1996 17.1Jan
  1, 1997 18.9
• The price at year-end is the same as the price
  at the beginning of the next year. If you buy 100
  shares in the beginning of 1990 and keep the
  dividends in non-interest bearing cash, how much
  is your portfolio worth at the end of 1996?

6

• We have 3,000 and invest this in an 8-year high
  yield bond in the beginning of the current year.
  The coupon rate is 7.5 and the coupon is paid
  out at the end of the year. As a philanthropist,
  you donate the coupon to the Red Cross every year
  as soon as you receive the cash. Inflation is
  running at 2.4 and its effects are calculated at
  the end of a year.
• In inflation adjusted terms, how much money will
  we have when the bond matures after having
  received the principal back?

7
Long Question Part 1
Two years ago you had 10,000 to invest and
decided to buy an 8-year bond with a face value
of 6,000 and a coupon rate of 5.25. You
invested the remaining money in a 2-year time
deposit with a 2 interest rate, and keep the
cash proceeds of the coupon in a non-interest
bearing current account. Assume that the coupon
is paid out yearly and that the first coupon will
be paid exactly one year after you purchase the
bond. Ever since, interest rates have been
dropping and currently the discount rate is
2.25. Including any cash you might have, what is
the total current value of your investments?
8
Long Question Part 2
Since the stock market has been doing really
well, you are considering 2 options. The first
option is to keep the Bond and invest the money
from the time deposit and the cash from the
coupons in stocks and also to invest any future
cash from the coupons in stocks. The second
option is to sell the Bond and invest everything
(including any cash you might have) in
stocks. Let us assume that the stock you pick
will show the following returns over the next
five years 6.3, 14.1, 6.9, 8.2, 10.1. For
option 1, calculate the total value of your
investments four years from now (at the end of
the year) assuming the discount rate will drop to
1.25 three years from now.
9
For option 2, calculate the total value of your
investments four years from now (at the end of
the year) assuming the discount rate will drop to
1.25 three years from now.