Grandpa Russ thinks he needs a fixed income for the next 10 years. He currently
ID: 2477267 • Letter: G
Question
Grandpa Russ thinks he needs a fixed income for the next 10 years. He currently has $10,000 in CDs, which are maturing at the end of this month. The CDs can be renewed for one year at 4.5 percent. Russ calls his broker, Ben Seller, and learns that this $10,000 can be put to better use by purchasing debentures issued by Grab-n-Run, Inc. These bonds are 10-year bonds with a coupon rate of 8 percent, which is paid semiannually. The current market interest rate is 6 percent for bonds of similar nature. The broker tells Grandpa Russ that he may buy each bond for $1,400. Grandpa knows that he must pay a premium, but he believes that a $400 premium is too high.
A. What is the maximum price you should tell Grandpa to pay for each bond?
B. Compare the risk of the CD with the risk of the bond.
C. What else would you advise Grandpa with regard to this type of investment?
Explanation / Answer
Answer to the Question
Point no( A)
Maximum price of the bond $1148.77 .
Point (B)
Risk of Cash Deposit is lower than the risk of investing in Bond.
Point No (C)
It is advisable to invest in Debentures since it gives higher return.
Value of investment in CD after 10 years $13,984.
Value of investment in debenture after 10 year $11,487.
Since the return is more from CD by $2497, it is advisable to invest in CD.
Year Cash flow PVF @ 6% DCF 1 40 0.971 38.83 2 40 0.943 37.70 3 40 0.915 36.61 4 40 0.888 35.54 5 40 0.863 34.50 6 40 0.837 33.50 7 40 0.813 32.52 8 40 0.789 31.58 9 40 0.766 30.66 10 40 0.744 29.76 11 40 0.722 28.90 12 40 0.701 28.06 13 40 0.681 27.24 14 40 0.661 26.44 15 40 0.642 25.67 16 40 0.623 24.93 17 40 0.605 24.20 18 40 0.587 23.50 19 40 0.570 22.81 20 40 0.554 22.15 20 1000 0.554 553.68 PV of cash in flow 1,148.77Related Questions
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