Essay: Financial Calculations

Sample Essay

E5–6 Jack and Jill have just had their first child. If college is expected to cost $150,000per year in 18 years, how much should the couple begin depositing annually at the end of each year to accumulate enough funds to pay the first year’s tuition at the beginning of the 19th year? Assume that they can earn a 6% annual rate of return on their investment.

PV of Annuity

PV = 150,000

PMT = ?

N =18

PV = PMT[1-(1/(1+i)^n))/i]

PMT = 13,853$

 

E6–1 The risk-free rate on T-bills recently was 1.23%. If the real rate of interest is estimated

to be 0.80%, what was the expected level of inflation?

 

= 1.23% * (0.80) = 0.98%

E6–2The yields for Treasuries with differing maturities on a recent day

a. Use the information to plot a yield curve for this date.

b. If the expectations hypothesis is true, approximately what rate of return do investors expect a 5-year Treasury note to pay 5 years from now?

MaturityYield

3 months 1.41%

6 months 1.71

2 years 2.68

3 years 3.01

5 years 3.70

10 years 4.51

30 years 5.25

The rate of return which an investor expect on a 5-year Treasury note 5 years from now is around 3.5%.

c. If the expectations hypothesis is true, approximately (ignoring compounding) what rate of return do investors expect a 1-year Treasury security to pay to start 2 years from now?

The rate of return which an investor expect on a 2-year Treasury note 5 years from now is around 2.35%.

d. Is it possible that even though the yield curve slopes up in this problem, investors

do not expect rising interest rates? Explain.

Yes it is possible because interest rate increase with the inflation

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