You currently have $15,000 that you plan to use to buy a car. You prefer a new c

Question

You currently have $15,000 that you plan to use to buy a car. You prefer a new car, but you are also open to a used car. Either way you will pay cash. The cost of a new car today (in 2012) is $22,500, but the cost for new versions of this car is projected to rise by 2% per year through 2017. Instead of a new car, you could buy a 2012 model later in the used-car market. The price of the 2012 model is expected to decline by 15% per year through 2017. You plan to invest your $15,000 into BBB-rated bonds, but you are not sure whether you should invest in successive one-year bonds, or in longer-term bonds. The five-year yield curve for zero coupon bonds rated BBB is given below to help you make your decision.

Term 1 year 2 years 3 years 4 years 5 years
YTM 10.00% 11.00% 12.00% 13.00% 14.00%


6. Which bond, if held to maturity, provides the earliest expected opportunity to buy a new car?
a. The two-year bond
b. The three-year bond
c. The four-year bond
d. The five-year bond
e. None of the above

Explanation / Answer

car price. (question asks for NEW CAR price so disregard the used car prices if it means BRAND new. if it means "new" in the sense of "new to you" then use used car data) Future Value (FV) = current value(1 + .rate) = New value year 0 (2012) = 22500 new, n/a for 2012 used year 1 (2013) = 22950 new, 19125 for 2012 used year 2 (2014) = 23409 new, 16256.25 for 2012 used year 3 (2015) = 23877.18 new, 13817.812 for 2012 used year 4 (2016) = 24354.723 new, 11745.14 for 2012 used year 5 (2017) = 24841.817 new, 9983.369 for 2012 used 1 year bond: 16500 (2013) 2 year bond: 18315 (2014) 3 year bond: 20146.5 (2015) 4 year bond: 23179.464 (2016) 5 year bond: 26424.588 (2017) all of these numbers were calc'd by base 15000 and the year's rate (15000 x 1.10 = 16500) for year 1, (16500 x 1.11 = 18315) for year 2 etc... using this data the 5 year bond (2017), to maturity, is the only way to afford a brand new car. for a used car (only in "new for you" scenario) 2014 (2 year bond)is the year you can get a "new" used car.

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.