You need $2,000 to buy a new stereo for your car. If you have $800 to invest at

Question

You need $2,000 to buy a new stereo for your car. If you have $800 to invest at 5% compounded 11 annually, how long will you have to wait to buy the stereo? A) 6.58 y ears. B) 8.42 years CO 14.58 years D) 15.75 years E) 18.78 years 12. A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than shot-term borrowing costs i called A) inverted yield curve B) normal yield curve C) flat yield curve D) None of the above 13 A firm has preferred stock outstanding with $100 par value and dividend of 4%. If the market price of the preferred stock is $50, the yield regd rate of return on the preferred stock is A) 4%, B) 6%, C) 8% D) None of the above

Explanation / Answer

11. Desired Amount = $ 2000

     Amount to invest = $ 800

    Rate of Interest = 5%

Putting it into the equation

A(1+rate of interest)^n = Desired Amount

800*(1+5%)^n = 2000

800*(1+0.05)^n = 2000

800*(1.05)^n = 2000

(1.05)^n = 2000/800

(1.05)^n = 2.5

Now through trial & error method, we arrive at n = 18.78 which equalizes both the side.

Hence, it will take 18.78 yrs to make $ 800 equal to $ 2000 at a rate of 5% compounded annually.

12. Inverted Yield Curve indicates generally cheaper long term borrowing costs than short term borrowing cost

13. Par Value = 100

   Dividend = 4%

Market Price of the preferred stock = 50

Required rate of Preferred Stock = Dividend/Market Price of the Preferred Stock

Dividend= 100*4% = $ 4

Putting the values in the above formula

= 4/50 = 8%

Hence 8% is the yield (rate of return ) on the preferred stock

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