GEK2507 Compound & Prosper GEK2507 Frederick H. Willeboordse

GEK2507 Exercises for Test 2

GEK2507 Important note: The sample questions provided here are for your reference only. The questions asked during the test will be similar in style but can be very different otherwise. For this test, most of the points will go to the long final question which is pretty tough!

GEK2507 Over any thirty year holding period, which had the worst recorded performance: bonds or stocks? When interest rates go up, does the market-value of a bond go up or down? Assume that you have $ in cash at the beginning of 2003 and that inflation is expected to run at the rates indicated to the right. In today’s dollars, how much is your money worth at the end of 2005? Expected Inflation Rates 2003: 20% 2004: 25% 2005: 33%

GEK2507 Let us assume you invest in a stock on Jan 1, 1990 that pays 3% dividend a year (to all shareholders who own stock on the 31st of the previous year) and that has the following share prices: Jan 1, 1990: 12.3 Jan 1, 1991: 14.3 Jan 1, 1992: 13.9 Jan 1, 1993: 15.2 Jan 1, 1994: 12.8 Jan 1, 1995: 16.3 Jan 1, 1996: 17.1 Jan 1, 1997: 18.9 The price at year-end is the same as the price at the beginning of the next year. If you buy 100 shares in the beginning of 1990 and keep the dividends in non-interest bearing cash, how much is your portfolio worth at the end of 1996?

GEK2507 We have $3,000 and invest this in an 8-year high yield bond in the beginning of the current year. The coupon rate is 7.5% and the coupon is paid out at the end of the year. As a philanthropist, you donate the coupon to the Red Cross every year as soon as you receive the cash. Inflation is running at 2.4% and its effects are calculated at the end of a year. In inflation adjusted terms, how much money will we have when the bond matures after having received the principal back?

GEK2507 Long Question Part 1: Two years ago you had $10,000 to invest and decided to buy an 8- year bond with a face value of $6,000 and a coupon rate of 5.25%. You invested the remaining money in a 2-year time deposit with a 2% interest rate, and keep the cash proceeds of the coupon in a non- interest bearing current account. Assume that the coupon is paid out yearly and that the first coupon will be paid exactly one year after you purchase the bond. Ever since, interest rates have been dropping and currently the discount rate is 2.25%. Including any cash you might have, what is the total current value of your investments?

GEK2507 Long Question Part 2: Since the stock market has been doing really well, you are considering 2 options. The first option is to keep the Bond and invest the money from the time deposit and the cash from the coupons in stocks and also to invest any future cash from the coupons in stocks. The second option is to sell the Bond and invest everything (including any cash you might have) in stocks. Let us assume that the stock you pick will show the following returns over the next five years: 6.3%, 14.1%, 6.9%, 8.2%, 10.1%. For option 1, calculate the total value of your investments four years from now (at the end of the year) assuming the discount rate will drop to 1.25% three years from now. For option 2, calculate the total value of your investments four years from now (at the end of the year) assuming the discount rate will drop to 1.25% three years from now.