In Need Of Help With Finance Homework Part 2

Originally posted by TheShooter
Here are the three problems I am having most trouble with this week...

Problem 1:

Assume that AT&T's pension fund managers are considering two alternative securities as investments: (1) Security Z (for zero intermediate cash flows), which costs $422.41 today, pays nothing during its 10-year life, and then pays $1,000 after 10 years or (2) Security B, which has a cost today of $1,000 and which pays $80 at the end of each of the next 9 years and then $1,080 at the end of Year 10

a. Assume that the interest rate AT&T's pension fund managers can earn on the fund's money falls to 6% immediately after the securities are purchased and is expected to remain at that level for the next 10 years. What would the price of each security change to, what would the fund's profit be on each security, and what would be the percentage profit (profit divided by cost) for each security?

b. Assuming that the cash flows for each security had to be reinvested at the new 6 percent market interest rate, (1) what would be the value attributable to each security at the end of 10 years and (2) what "actual, after-the-fact" rate of return would the fund have earned on each security? (Hint: The "actual" rate of return is found as the interest rate that causes the PV of the compounded Year 10 amount to equal the original cost of the security.)

c. Now assume all the facts as given in parts a and b except assume that the interest rate rose to 12 percent rather than fell to 6 percent. What would happen to the profit figures as developed in part a and to the "actual" rates of return as determined in part b? Explain the results.
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If the prevailing rate drops to 6%, the bonds will go up in value (remember the inverse relationship?) But the will go up to different extents – b/c, as you’ll learn later they have different “durations”, the zero coupon bond’s duration is exactly 10 years, it’s shorter for the plain vanilla bond (b/c the average time to your pmts is shorter since you get something sooner). Now the prices:
Price_of_Z=1000*PVIF10,6%=558.5 the bond increased by 135.99 bucks or 32.19%
Price_of_B=80*PVIFA10,6%+1000*PVIF10,6%=80*7.3601+558.5=1147.31 =>the price went up by 147, or by 14.73%

Security Z is a zero coupon bond. PV = 422.41, FV=1000. ten periods,
422.41=1000*PVIF10,i
=>PVIF10,i=0.4224
PVIF=1/(1+i)^n
From that: I=9%
Security B is a plain vanilla bond. It costs a grand and pays the face value of a grand in 10 years. It also pays 80 per year in coupons. Because it costs exactly as much as the face value – the required rate must be equal to the coupon rate, the latter is 8% (b/c the coup.pmts are 80 bucks). Hence, i=8%
…just in case smth like this comes up on the test :D
You know what dude, that's about as much time as I can waste on this :D Trust me, it is all in the book. If you can't get it yourself, the tutors are what... 10 bucks an hour? I'm sure you can cover those costs with your daytrading profits :D
 
Originally posted by daniel_m
QQQball,
it used to be a matter of pride in communist countries to be able to do complex calculations without calculators...
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I did not say "without" calculators :D I said you didn't have to have the financial caclulator. It's not worth what they charge for it. I agree that any student should invest in a quality calculator, but I think it should be a general scientific one. You would not believe how many students I get in the senior level course (who took the intro with someone else and only used the calculator), who get lost once the compounding is switched or if I tweak the problem a bit. Why? B/c they never stopped to think about the underlying mechanics when they learned the basic stuff. Another good example, all fin.calculators come with a bunch of default settings. Students usually dump the manuals and they can't figure out on the test why they are not getting one of the options... They have to know what the defaults are (e.g. ordinary annuity vs. annuity due etc) and how to switch those. By the time they can figure smth out (if ever), they would have computed everything by using a plain calculator and a formula.
PS No need to reignite the whole comunist bitching, dude. It was out of line here. Will you get over it?
PPS I'm not a number crunching freak, by the way. My wife is doing her PhD in nuclear physics and compared to what she can do, I am utterly humbled. I never really enjoyed crunching the numbers unless they had $$ signs next to them. If they do, I believe anyone interested in finance needs to understand the logic, not just do it in a perfunctory "plug in the values" way.
:cool:
 
Originally posted by TheShooter
To all the smart asses,

Listen up you elitist hacks. I am posting these damn problems here because I want to learn how they are done. You can only look at a text book so long; after about 3 hours of nothing "clicking" it was more than appropriate to seek out another source, the knowledgable people of this site.
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Well having taught these types of topics my comments would be:

(1) You will get some help here but the best source of information is usually getting together with a study group of your peers, going to the university library and consulting other textbooks, and simply consulting your professor or TA's during their office hours. If you dont have any faith in your professors abilities to answer your questions in a "real world" way then you need to talk to your department chairman or the dean about the quality of the class and instructor.

(2) These problems can be looked at from different points of view - levels of complexity. They seem a bit light for graduate level courses however. If you have a chance take a look at the books written by Fabozzi.
 
Originally posted by CalTrader


(2) These problems can be looked at from different points of view - levels of complexity. They seem a bit light for graduate level courses however. If you have a chance take a look at the books written by Fabozzi.
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I think they must be doing a review of the basics before getting into more advanced stuff (it's the beginning of the semester after all). I agree on the Fabozzi choice. I'd also recommend Van Horne. Although, I think any book they are using should explain such problems. If shooter spent three hours perusing the book with "nothing clicking", he must have been looking in the wrong chapter :D
 
I agree with Vladiator. Financial calculators are a useless tool unless you understand how the inputs relate to the output.

Shooter needs to understand the "roadmap" to get to the destination rather than the total miles to get there. These are basic lower/upper division undergrad questions which should be clearly laid out within the textbook. It's about the bigger issue of learning to problem solve and applying the formulae than getting the answer. Take the time to find appropriate example within the text and apply those examples to the questions at the end of the chapter.

Later,

Cracked
 
Dude,

Some of these guys that your busting their balls about are <real> traders NOT posers........I'd ease up sonny.......

just my .02 cents worth and it probably won't change you one bit...

mrktwiz
 
Originally posted by TheShooter
To all the smart asses,

Listen up you elitist hacks. I am posting these damn problems here because I want to learn how they are done. You can only look at a text book so long; after about 3 hours of nothing "clicking" it was more than appropriate to seek out another source, the knowledgeable people of this site.
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Where in your first message do you ask for anything other than the answers. You do not request an explanation. You come to a site about trading and ask questions which IMO was and is seeking the easy way out. Elitist hack - I like that one.

Sounds like you're taking an MBA. Besides ethics which is surely part of the curriculum, make sure you work on your presentation skills.
 
I agree that financial calculators such as the HP-12C aren’t necessary, but they can be handy when you need a response quickly. Programming a HP48G/GX is another way to go and it will give more versatility. For the purposes of learning setting the problems up in Excel is a great way to see how the cash flows add up, interest rates affect PV/FV etc.

Just my IB round-trip stock commission…

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Damn I miss school… GIRLS, trading, GIRLS, classes, GIRLS, partying, GIRLS… repeat.
 
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