(a) Why investors pay more attention to the time preference for money when makin
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Question
(a) Why investors pay more attention to the time preference for money when making their financial decisions? (2 Marks) What is meant by the term structure of interest rates? Discuss briefly the main theories used to explain it. (3 Marks) You have decided to buy a new car and you have three financing alternatives. First, you can pay Rs.2,000,000 in cash for the car. Second, you can buy the car on an instalment plan by paying a Rs.500,000 down payment and promising to pay Rs.500,000 per year at the end of each of the next four years. The third alternative, a low-cost lease plan, involves an annual payment of Rs.400,000 payable at the beginning of each of the next five years. in addition to the lease payments, you are forecasting that you will have to make another Rs.500,000 payment at the end of the fifth year in order to meet the dealer's residual value requirement. You have determined that you can invest your money at a 10% effective annual rate of return, and have decided to use that rate in comparing the three financing alternatives. Which financing alternative would you prefer? (5 Marks) (b) (c) NL Ltd. has issued a 10% bond that is to mature in 10 years. The bond has a Rs. 1,000 par value and interest is paid semi-annually. If your required rate of return is 8% per annum which continues for the foresecable future, what price would you be willing to pay for this bond after five years from the issued date? (5 Marks) A company's current dividend per share is 80 cents. The dividend of this company has been growing at 12 percent per year in recent years, a rate expected to be maintained for a further 3 years. It is then envisaged that the growth rate will decline to 5 per cent per year and remain at the level indefinitely Calculate the current share price of the company if the required rate of return is 14%. (5 Marks) (e)Explanation / Answer
As per rules I will answer the first 4 subparts of the question
A:Investors need to understand the present and future value of their investments. This is because there is an opportunity cost of investment and they need to assess this cost before making the investment.
B: The term structure of interest rates is the relationship between interest rates or bond yields and different terms. It is the yield curve of the bond and reflects the investors’ expectations about future rates of interest.
C:PV of first option = $2,000,000
PV of option 2= 500000+500000*(1-1/(1+0.1)^4)/0.1=2,084,933
PV of option 3 = 400000+400000*(1-1/(1+0.1)^4)/0.1+500000/1.1^5= $1,978,406.84
Option 3 is the best one.
D:N=5*2= 10
Coupon= 10%/2 * FV = 5%*1000 = $50
I/Y= 8%/2 = 4%
FV= 1000
Using financial calculator;
PV= $1081.11
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