Tutorial 3 - Basic Finance

BWFF1013 FOUNDATIONS OF FINANCE (A112)NAME: ____________________________ (

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TUTORIAL 3

TOPIC: TIME VALUE OF MONEY

PART A: CONCEPTUAL

1. On the right are 6 diagrams representing 6 different present and future value concepts stated on the left. Identify the diagrams with the concepts by writing the identifying letter of the diagram on the blank line at the left. (See Example A)

Concept Diagram of Concept

Diagram e_ A. Future value ? $1

a. | | | | |_________ B. Present value

?_________ C. Future value of an annuity due $1 $1 $1 $1

b. |- - - - | | | |_________ D. Future value of an ordinary annuity

?_________ E. Present value of an ordinary annuity $1 $1 $1 $1

c. | | | |- - - - |_________ F. Present value of an ordinary due

? $1 $1 $1 $1

d. | | | | |

$1 ?

e. | | | | |

$1 $1 $1 $1 ?

f. | | | |

2. Match the following with the items below:

a. Annuity b. Future value of an annuity duec. Discount rate d. Perpetuitye. Present value f. Semi-annual compounding

i. __________ The payment of an equal stream of cash at the beginning of year into a fund which increases in size up to a future point in time.

ii. __________The interest or return is accumulated every six months.

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iii. __________ The discounted value of a future sum or annuity as of today's value.iv. __________ A series of consecutive payments or receipts of an equal amount.v. __________ The percentage rate at which future sums or annuities are brought back to

their present value.vi. __________ A constant stream of identical cash flows with no maturity.

3. Explain the importance of the time value of money and how it is related to an investor’s opportunity costs.

4. Define compound interest and explain how it works.

5. Would you rather have a saving account that pays 10% interest compounded semiannually or one that pays 10% interest compounded daily? Why?

6. What effect would a decrease in the interest rate have on the future value? What effect would an increase in the holding period have on the future value? Discuss.

7. What effect does increasing the interest rate have on the present value of a future value? Why?

8. Differentiate between an ordinary annuity and an annuity due. Which one is more valuable? Why?

PART B: CALCULATION

1. Suppose that you invest RM100 into your bank account today, the interest rate is 8% annually

a. How much will you have in 3 years if the bank compounds interest annually?b. How much will you have in 3 years if the bank compounds interest semiannually?c. What can you explain about the relationship between Questions (a) and (b)?d. How much will you have in 3 years if the bank increases the interest rate to 10%

semiannually? What can you explain when the interest rate increases.e. If you plan to have RM1,000 in your bank account in 3 years, the interest rate is 8%

annually, how much do you have to deposit today?

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2. WuiLing invested in gold U.S. coins 10 years ago, paying RM197.96 for one-ounce gold coins. He could sell these coins for RM734 today. What was his annual rate of return for this investment?

3. You’re trying to save to buy a new RM160,000 Honda Hybrid. The bank pays 8.7% annual interest on its accounts. If you believe you can buy the car in 10 years on the day you turn 35, how much must you invest today?

4. Kate Holmes has a RM1,200 overdue debt for medical books and supplies at Kohino's Bookstore. She has only RM400 in her checking account and doesn't want her parents to know about this debt. Kohino's tells her that she may settle the account in 1 of 2 ways since she cannot pay it all now.

Alternative 1: Pay RM400 now and RM1,000 when she completes her residency, 2 years from today.

Alternative 2: Pay RM1,600 one year after completion of residency, which is 3 years from today.

Assuming that the cost of money to her is 8%. Which alternative should she choose?

5. Norish O’Goughn started a saving plan on 1st January 2008. At the end of every 3 months, she deposits RM500 in her bank account, which earns 4% annually but is compounded quarterly. On 31st December 2011 she withdraws all the money in her bank account to invest in a unit trust that pays 9% annually. How much will she have on 31st December 2014?

6. As a rising composer, Dane Gig will receive RM19,500 for the next 20 years as a payment for a new hit ballad song he has written. If a 10% rate is applied, should he be willing to sell out his future rights now for RM160,000? Prove your answer.

7. Your neighbor will sell you an antique rack for RM72,500. He says the price is firm whenever you can pay him cash. You know your finances will only allow you to save RM5,000 a year and you can make 8% on your investment. If you invest faithfully every year at the end of the year, how long will it take you to accumulate the necessary RM72,500 future cash for the rack?

8. Marsha established a savings account for her son's college education by making annual deposits of RM6,000 at the beginning of each of 6 years to a savings account paying 8%. At the end of the sixth year, the account balance was transferred to a bank paying 10%, and

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annual deposits of RM6,000 were made at the end of each year from the seventh through the tenth years. What was the account balance at the end of the tenth year?

9. An insurance company has just launched a security that will pay RM150 indefinitely, starting the first payment next year. How much should this security be worth today if the appropriate return is 10%?

10. Augustine Anton has invested RM100,000 in an account at his local bank. The bank will pay him a constant amount each year for 6 years, starting 1 year from today, and the account's balance will be 0 at the end of the sixth year. If the bank has promised Anton a 10% return, how much will they have to pay him each year?

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Tutorial 3 - Basic Finance

Economy & Finance

Transcript of Tutorial 3 - Basic Finance