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W. Rentz

FINANCIAL MANAGEMENT

Assignment #1

lab on Wed., Jan. 21 for Sections M and N and Mon., Jan. 19 for Section P. It is

your responsibility to hand in your assignment directly to the tutor for lab

associated with the section in which you are registered. Please do NOT hand in

your assignment in the wrong lab or to the professor. This assignment counts 5% of

your course grade. You are encouraged to work on this assignment in teams

of up to 5 students from the same section of this course. However, you

may turn in an individual assignment if you prefer. Each assignment must be

typed and contain the student name(s) and student number(s) on each page.

A statement of integrity must be attached to each assignment (See page 8 of

the course syllabus). Each individual whose name appears on the

assignment must sign the statement of integrity.

a. In 4 years compounded at 8% per year.

b. In 8 years compounded at 4% per year.

c. In 4 years compounded at 16% per year.

d. Explain the difference in your results for parts a. and b.

2. You have borrowed $100,000 at 10% interest compounded yearly that is to be repaid in

level annual repayments over the next three years. Construct a loan amortization schedule

showing the total payment, interest payment, principal payment, and remaining balance

for each of the three years. Also show the total interest and total principal paid over the

three years. Note that the total payment for year 3 may have to be adjusted slightly

to exactly amortize the loan (i.e. zero remaining balance) at the end of three years.

3. You plan to buy a truck that costs $60,000. The dealer quotes you a yearly payment of

$12,979 for the next six years. What is the annual compound interest rate on this loan?

4. The patent on a new drug will last for 20 years. You expect that the net cash flow from

this drug will be $4.4 million for the first year and will grow at a compounded rate of

10% per year for each of the remaining 19 years of patent protection. After the patent

expires, you expect that this drug will no longer contribute to net cash flow of the firm.

Suppose that the required rate of return on such a project is 10%. Should the firm invest

in this project if it requires $60 million today to develop this drug?

3

5. You plan to save $10,000 per year at the end of each year for the next 30 years.

a. Assume that you can earn a compounded rate of 3% per year for the next ten years

and then a compounded rate of 4% per year thereafter. How much will you have

accumulated at the end of 30 years?

b. Instead of investing $10,000 per year, what would be the required lump-sum amount

today to give you the same accumulated amount in 30 years?

c. You plan to live for 20 years after retirement, and the interest rate during your

retirement years will be 5% per year. How much could you withdraw each year for 20

years with the first withdrawal being one year after your last deposit of $10,000?

Please assume that you will exactly exhaust your funds with the last withdrawal.

d. A more realistic assumption is that you must start your annual withdrawals

IMMEDIATELY after making your last deposit. That is, each withdrawal is at the

BEGINNING of each year of the twenty years of your retirement. How much does

this REDUCE the size of each withdrawal in part c.?

e. Suppose that you wish to leave a bequest of $200,000 when you die in 50 years (i.e.

20 years after your last deposit). Again assuming as in part d. that you make your 20

annual withdrawals at the BEGINNING of each year of retirement, what will now be

the size of your annual withdrawals?

f. Repeat part e. assuming that you want to withdraw $50,000 at the BEGINNING of

each year of retirement. How long can you afford to live, assuming that you still wish

to leave a bequest of $200,000?

g. Assume that you can afford to save only $10,000 per year but wish to retire with $2

million in 30 years before making your first withdrawal. Further assume that the

compounded interest rate is 3% per year for the next 10 years. What compounded

interest rate must you earn on your deposits in years eleven through thirty to retire

with $2 million?

6. The Bow River Mutual Fund of Calgary has CAD10 million that it can invest in

guaranteed investment certificates (GICs) at the Scotiabank for next six months.

Scotiabank is offering a 1.25% six-month yield on these GICs. The Chief Investment

Officer (CIO) Jean-Pierre Charette at Bow River is looking for opportunities that offer

greater return. He notes that Union Bank Switzerland (UBS) is offering Swiss Franc

certificate of deposits (CDs) which are of comparable default risk that have a 1.5% six-

month yield. The CIO, however, is worried about exchange rate risk. He obtains the

following exchange rate quotes for the Swiss Franc:

One-Month Forward Rate CAD0.5990/CHF

Three-Month Forward Rate CAD0.5980/CHF

Six-Month Forward Rate CAD0.5970/CHF

One-Year Forward Rate CAD0.5960/CHF

4

a. If the UBS CDs are purchased and held to maturity, determine the net gain (loss)

relative to the Scotiabank GICs, assuming that the spot rate in six months equals

today’s spot rate.

b. Suppose that the CHF declines by 3 percent relative to the CAD over the next six

months. Determine the net gain (loss) of the UBS CDs relative to the Scotiabank

GICs.

c. Determine the net gain (loss) from a covered position.

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