You have just won the lottery. You will receive $1,000,000 today, and then receive 40 payments of $500,000. These payments will start one year from now and will be paid every six months. A representative from Greenleaf Investments has offered to purchase all the payments from you for $10 million. If the appropriate interest rate is 8.9% APR compounded daily, should you take the offer. Assume there are 12 months in a year, each with 30 days.
11. What is the effective six-month interest for 8.9% APR compounded daily?
12. What is the PV of 40 payments of 500,000 at the time of today?
13. What is the PV of all the payments from the lottery winning at the time of today?
14. Financial markets are usually classified by the type and maturity of the financial assets traded. The two main classifications are as follows:
A. Bond market and money market
B. Money market and capital market
C. Bond market and foreign-exchange market
D. Commodity market and capital market
15. Which of the following is an example of an agency cost?
A. A company always buys the latest computer equipment for its employees
B. Senior management receives stock options enabling them to buy company stock at an exercise price well above the current stock price
C. Managers can use the company float plane to fly to their cottages on weekends
D. Sales reps are provided with company cars to use when visiting clients
20. Joe has just borrowed $1,000 from his grandmother in order to make a down payment on a car. This borrowing transaction is an example of:
A. Indirect intermediation
B. Direct intermediation
C. External intermediation
D. Market transaction
Part 2 Practice Problems (10 marks)
1. Consider 2 bonds, A and B. The coupon rates are 10% and the face values are $1,000 for both bonds. Both bonds have annual coupons. Bond A has 15 years to maturity while bond B has 25 years to maturity. (6 marks)
a) What are the prices of the two bonds if the relevant market interest rate for both bonds is 11%?
b) What are the prices of the two bonds if the relevant market interest rate increases to 12.9%?
c) What are the prices of the two bonds if the relevant market interest rate decreases to 7.6%?
2. Southern Ontario Publishing Company is trying to decide whether to revise its popular textbook, Introduction to Corporate Finance. The company has estimated that the revision will cost $50,000. Cash flows from increased sales will be $12,000 the first year. Theses cash flows will increase by 6% per year. The book will go out of print five years from now. Assume that the initial cost is paid now and revenues are received at the end of each year. If the company requires an 11% return for such an investment, should it undertake the revision? (4 marks)