You are the Chief Executive Officer or ANZ, a AA rated bank. a. If you wanted to

Question

You are the Chief Executive Officer or ANZ, a AA rated bank. a. If you wanted to raise debt financing using direct financing, what security would you most likely issue? Why? (2 marks) b. The company has $20,000,000 to invest over a period of 4 years. You have two options: 1)Invest a lump sum of $20,000,000 in bonds for 4 years and make a return of 4.5% p.a. with interest compounded semi-annually. 2) Invest only $5,000,000 of the $20,000,000 every year, at the end of the year, for 4 years into a deposit account which yields 5% p.a. with interest compounded annually. What is the future value from both options and which would you chose? Why? (3 marks)

with harvard reference reference please?

Explanation / Answer

a. If i wanted to raise debt financing, that too direct financing (i.e without the use of an intermediary), then i would go for wholesale deposits. As the bank is rated reasonably well (AA) it will be able to attract wholesale sources of funds. Its good rating will ensure lower interest rate that is paid due to lower level of risks. Thus the bank will be able to raise debt without using any intermediaries and the cost of loan will be lower as well due to its AA rating. (The AA rating denotes a strong capacity of the bank to meet its  financial commitment on the loan).

b. 1. The lump sum investment is $20,000,000. time = 4 years and n = 2 (as semi annual). r = 4.5%

Thus future value = lump sum investment*(1+r/n)^n*t

= 20,000,000*(1+4.5%/2)^4*2 = 20,000,000*1.1948311 = $23,896,622.84

2. Now, only $5,000,000 is invested every year at the end of the year:

End of year 1 will see a deposit of 5,000,000. No interest will be paid.

Year 2: Opening balance = 5,000,000. Interest = 5% of 5,000,000 = 250,000. End of the year balance = opening balance+interest+$5,000,000 yearly deposit = $10,250,000 (5,000,000+250,000+5,000,000)

Year 3: Opening balance =  $10,250,000. Interest = 5% of 10,250,000 = 512,500. End of the year balance = opening balance+interest+$5,000,000 yearly deposit = $10,250,000 + 512,500 + 5,000,000 = $15,762,500

Year 4:  Opening balance = $15,762,500. Interest = 5% of $15,762,500 = 788,125. End of the year balance = opening balance+interest+$5,000,000 yearly deposit = $15,762,500+788,125+5,000,000 = $21,550,625

Option 1 will be selected as it has a higher future value.  

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