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Mathematics answers to MBA711 book.

- MBA711 - Answers to Book - Chapter 3
- MBA711 - Answers to Book - Chapter 5
- MBA711 - Chapter 10 - Answers to All Questions
- MBA711 - Answers to All Chapter 7 Problems
- MBA711 - Chapter11 - Answers to All Homework Problems
- Valuing Bonds
- MBA711 - Chapter 9 - Answers to All Problems
- MBA711 - Chpt 6 - Valuing Bonds - classnotes.pdf
- Citibank - Basics of Corporate Finance
- Operations Management, ch4 by heizer
- MBA711 - Answers to All Chapter 7 Problems
- Chapter 13 - HW With Solutions
- Capital Expenditure - Report
- Ch4ProbsetTVM13ed - Master
- Chapter 12 - HW Solutions
- Finance Applications and Theory (McGraw-HillIrwin Series in Finance, Insurance and Real Estate) Compressed
- lecNo_6
- L09
- Chp_11_&_12-extra question 12.312.412.5
- CEMRE - MS Excel Extra Tutorial

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FLOWS

Questions

LG1

1. List and describe the purpose of each part of a time line with an initial cash inflow and

a future cash outflow. Which cash flows should be negative and which positive? Why?

The cash flow timeline is a visual depiction of inflows and outflows relative to the period

under consideration. Cash flows are illustrated above the cash flow line with the

corresponding periods that apply appearing under the cash flow diagram. Inflows are

represented by positive numbers and outflows by negative numbers.

LG2

The measure that relates present values to future values is the interest rate i. A present

value can be moved forward in time with interest to arrive at the future value (

N

Future value in N years FV N PV 1 i ). A future value can be discounted back to

the present by rearranging the equation so that the FV is divided by the interest factor.

LG3

3. Would you prefer to have an investment earning 5 percent for 40 years or an investment

earning 10 percent for 20 years? Explain.

Investments of $1 will grow to $7.04 in 40 years (= $1.0540) and $1 will grow to $6.73 in

20 years (= $1.1020). The 5 percent investment for 40 years is worth more. This example

illustrates the importance of time in building wealth.

LG4

Interest rates have an inverse relationship to present values. Increases in expected interest

rates result in lower present values because future values are discounted at a high rate to

become smaller present values. Decreases in expected interest rates result in higher

present values because future values are discounted at a lower rate.

LG5

5. What do you think about the following statement. I am going to receive $100 two

years from now and $200 three years from now, so I am getting a $300 future value.

How could the two cash flows be compared or combined?

Cash flows may only be combined when they are moved to the same point in time. The

statement above is incorrect in that it compares the $100 cash flow after year 2 with the

$200 cash flow after year 3. To make comparisons meaningful, the cash flows need to be

considered at the same point in time. Either the $100, 2 nd year cash flow could be moved

to year 3, or the $200, 3rd year cash flow could be moved to year 2 for combining.

4-1

Chapter 4 Solutions

LG6

6. Show how the Rule of 72 can be used to approximate the number of years to quadruple

an investment.

The Rule of 72 is a rule of thumb that approximates the amount of time necessary for an

investment to double given a certain level of interest expressed in percentage form.

Therefore, an investment of 8% interest will take approximately 9 years (= 72/8) to double

according to the Rule of 72. It would then take another 9 years for this amount to double.

Therefore, it would take 18 years for the original investment to quadruple at an 8 percent

rate.

LG7

7. Without making any computations, indicate which of each pair has a higher interest

rate?

a. $100 doubles to $200 in 5 years or 7 years.

b. $500 increases in 4 years to $750 or to $800.

c. $300 increases to $450 in 2 years or increases to $500 in 3 years.

a. $100 doubling to $200 in 5 years has the higher interest rate.

b. $500 increasing to $800 in 4 years has a higher interest rate.

c. $300 increasing to $450 in 2 years has the higher interest rate.

LG8

return. How much longer will it take for the investment to reach $4,000 if it continues

to earn a 9 percent rate?

The Rule of 72 predicted that $1000 will double to $2000 in 8 years at 9 percent interest.

Another doubling from $2000 to $4000 will occur in eight more years at 9 percent, again

predicted by the Rule of 72.

Problems

Basic

Problems 4-1 Time Line Show the time line for a $300 cash inflow today, a $363 cash outflow in

LG1 year two, and a 10 percent interest rate.

The time line for this problem is:

Cash Flow

300

Period 0

LG1

-363

10%

10%

2 years

4-2 Time Line Show the time line for a $400 cash outflow today, a $518 cash inflow in

year three, and a 9% interest rate.

4-2

Chapter 4 Solutions

Cash Flow

-400

Period 0

LG2

518

9%

9%

9%

3 years

4-3 One Year Future Value What is the future value of $500 deposited for one year

earning a 9% interest rate annually.

FVN = PV (1 + i)N

FV1 = 500 (1 + 0.09)1

= 500 1.09

= 545

LG2

4-4 One Year Future Value What is the future value of $400 deposited for one year

earning an interest rate of 11 percent per year?

FVN = PV (1 + i)N

FV1 = 400 (1 + 0.11)1

= 400 1.11

= 444

LG3

4-5 Multi-Year Future Value How much would be in your savings account in 8 years

after depositing $150 today if the bank pays 7 percent per year?

FVN = PV (1 + i)N

FV8 = 150 (1 + 0.07)8

= 150 1.71819

= 257.73

LG3

4-6 Multi-Year Future Value Compute the value in 25 years of a $1,000 deposit earning

10 percent per year.

FVN = PV (1 + i)N

FV25 = 1000 (1 + 0.10)25

= 1000 10.83471

= 10,834.71

LG3

4-7 Compounding with Different Interest Rates A deposit of $350 earns the following

interest rates:

8 percent in the first year,

7 percent in the second year, and

5 percent in the third year.

What would be the third year future value?

4-3

Chapter 4 Solutions

Cash Flow

-350

Period 0

8%

7%

5%

3 years

FV = PV (1 + i) (1 + j) (1 + k)

FV = 350 (1 + 0.08) (1 + 0.07) (1 + 0.05)

= 350 1.08 1.07 1.05

= 424.68

LG3

4-8 Compounding with Different Interest Rates A deposit of $750 earns interest rates of

10 percent in the first year and 12 percent in the second year. What would be the second

year future value?

The time line for this problem is:

Cash Flow

-750

Period 0

10%

12%

2 years

FV = PV (1 + i) (1 + j)

FV = 750 (1 + 0.10) (1 + 0.12)

= 750 1.10 1.12

= 924.00

LG4

4-9 Discounting One Year What is the present value of a $250 payment in one year when

the discount rate is 10 percent?

PV = FV/(1+i)

PV = 250/(1+0.10)

= 250/1.10

= 227.27

LG4

4-10 Discounting One Year What is the present value of a $400 payment in one year

when the discount rate is 7 percent?

PV = FV/(1+i)

PV = 400/(1+0.07)

= 400/1.07

= 373.83

4-4

Chapter 4 Solutions

LG4

4-11 Present Value What is the present value of a $1,500 payment made in 5 years when

the discount rate is 8 percent?

PV = FV/(1+i)N

PV = 1500/(1+0.08)5

= 1500/1.46933

= 1020.87

LG4

4-12 Present Value Compute the present value of a $850 payment made in 10 years when

the discount rate is 12 percent.

PV = FV/(1+i)N

PV = 850/(1+0.12)10

= 850/3.10585

= 273.68

LG4

4-13 Present Value with Different Discount Rates Compute the present value of $1,000

paid in three years using the following discount rates; 6 percent in the first year, 7 percent

in the second year, and 6 percent in the third year.

PV = FV/[(1 + i) (1 + j) (1 + k)]

PV = 1000/[(1 + 0.06) (1 +0.07) (1 + 0.06)]

= 1000/[1.06 1.07 1.06]

= 1000/1.2023

= 831.77

LG4

4-14 Present Value with Different Discount Rates Compute the present value of $5,000

paid in two years using the following discount rates; 8 percent in the first year and 7

percent in the second year.

PV = FV/[(1 + i) (1 + j) ]

PV = 5000/[(1 + 0.08) (1 + 0.07)]

= 5000/[1.08 1.07]

= 5000/1.1556

= 4326.76

LG6

4-15 Rule of 72 Approximately how many years does it take to double a $100 investment

when interest rates are 7 percent per year?

N = 72/7

LG6

10.3 years

4-16 Rule of 72 Approximately how many years does it take to double a $500 investment

when interest rates are 10 percent per year?

4-5

Chapter 4 Solutions

N = 72/10

LG6

14.4 years

4-18 Rule of 72 Approximately what interest rate is earned when an investment doubles

over 12 years?

N = 72/12

LG7

7.2 years

4-17 Rule of 72 Approximately what interest rate is needed to double an investment over

5 years?

N = 72/5

LG6

6 percent

4-19 Rates over One Year Determine the interest rate earned on a $1,500 deposit when

$1,700 is paid back in one year.

1500(1 + i) = 1700; Solving for i yields 13.33%

LG7

4-20 Rates over One Year Determine the interest rate earned on a $2,300 deposit when

$2,700 is paid back in one year.

2300(1 + i) = 2700; Solving for i yields 17.39%

Intermediate

Problems 4-21 Interest-on-Interest Consider a $1,000 deposit earning 8 percent interest per year

LG3 for 5 years. What is the future value, and how much total interest is earned on the original

deposit vs. how much is interest earned on interest?

The $1000 investment will grow to a future value of $1,469.33 [= FV5 = 1000(1+0.08)5],

assuming compounded interest over the 5 years. The total interest earned is $469.33. The

interest earned on the original investment is $80 per years for 5 years, or $400. The

interest earned on the interest is the difference $69.33 [= $469.33 $400].

LG3

4-22 Interest-on-Interest Consider a $5,000 deposit earning 9 percent interest per year

for 10 years. What is the future value, and how much total interest is earned on the

original deposit and how much is interest earned on interest?

The $5000 investment will grow to a future value of $11,836.82 [= FV10 =

5000(1+0.09)10], assuming compounded interest over the 10 years. The total interest

earned is $6,836.82. The interest earned on the original investment is $450 per years for

10 years, or $4,500. The interest earned on the interest is the difference $2,336.82 [=

$6836.82 $4500].

4-6

Chapter 4 Solutions

LG5

4-23 Comparing Cash Flows What would be more valuable, receiving $500 today or

receiving $625 in three years when interest rates are 9 percent? Why?

PV = FV/(1+i)N

PV = 625/(1+0.09)3

= 625/1.295029

= 482.61

The present value of $625 to be paid in three years at 9% interest is $482.61. This amount

is worth less than $500 received today. Therefore the $500 payment made today is more

valuable.

LG5

4-24 Comparing Cash Flows Which cash flow would you rather pay, $400 today or $500

in two years when interest rates are 10 percent? Why?

PV = FV/(1+i)N

PV = 500/(1+0.10)2

= 500/1.21

= 413.22

The present value of $500 to be paid in two years at 10% interest is $413.22. This amount

is higher than $400 received today. Therefore, paying the $400 today is cheaper.

LG5

4-25 Moving Cash Flows What is the value in year 3 of a $700 cash flow made in year 7

when interest rates are 10 percent?

PV = FV/(1+i)N

PV = 700/(1+0.10)(7-3)

= 700/1.4641

= 478.11

LG5

4-26 Moving Cash Flows What is the value in year 4 of a $900 cash flow made in year 6

when interest rates are 8 percent?

PV = FV/(1+i)N

PV = 900/(1+0.08)(6-4)

= 900/1.1664

= 771.60

LG5

4-27 Moving Cash Flows What is the value in year 10 of a $1,000 cash flow made in year

5 when interest rates are 9 percent?

FVN = PV (1 + i)N

FV(10-5) = PV (1 + i)(10-5)

4-7

Chapter 4 Solutions

= 1000 1.5386

= 1538.62

LG5

4-28 Moving Cash Flows What is the value in year 15 of a $250 cash flow made in year 3

when interest rates are 12 percent?

FVN = PV (1 + i)N

FV(15-3) = PV (1 + i)(15-3)

FV12 = 250 (1 + 0.12)12

= 250 3.89598

= 973.99

LG7

4-29 Solving for Rates What annual rate of return is earned on a $1,000 investment when

it grows to $2,500 in six years?

FVN = PV (1 + i)N

2,500 = 1,000 (1 + i)6

(1 + i)6 = 2500/1000

(1 + i)6 = 2.5

i = (2.5)(1/6) -1 = 0.165 or 16.5%

LG7

4-30 Solving for Rates What annual rate of return is earned on a $5,000 investment when

it grows to $9,500 in five years?

FVN = PV (1 + i)N

9,500 = 5,000 (1 + i)5

(1 + i)5 = 9500/5000

(1 + i)5 = 1.9

i = (1.9)(1/5) -1 = 0.137 or 13.7%

LG8

4-31 Solving for Time How many years (and months) will it take $2 million to grow to

$5 million with an annual interest rate of 7 percent?

FVN = PV (1 + i)N

$5 million = $2 million (1 + 0.07)N

(1.07)N = 5/2 (the millions cancel)

ln (1.07)N = ln 2.5

N ln 1.07 = ln 2.5

N = ln 2.5/ln 1.07 = 0.916290732/0.067658648 = 13.54 years

= 13 years, 6.5 months

OR use footnote 4 formula:

N

= ln(fv/pv)/ln(1+i)

= ln(5000/2000)/ln(1.07)

4-8

Chapter 4 Solutions

LG8

4-32 Solving for Time How long will it take $2,000 to reach $6,000 when it grows at 10

percent per year?

FVN = PV (1 + i)N

6,000 = 2,000 (1 + 0.10)N

(1.10)N = 6/2 (the thousands cancel)

ln (1.10)N = ln 3

N ln 1.10 = ln 3

N = ln 3/ln 1.10 = 1.098612289/0.09531018 = 11.53 years

= 11 years, 6.3 months

OR use footnote 4 formula:

N

= ln(fv/pv)/ln(1+i)

= ln(6000/2000)/ln(1.10)

= 11.53 years = 11 years, 6.3 months

Advanced

Problems

LG2

4-33 Future Value At age 30 you invest $1,000 that earns 9 percent each year. At age 40

you invest $1,000 that earns 12 percent per year. In which case would you have more

money at age 60?

FVAge 60 = PVAge 30 (1 + i)Years until age 60

FVAge 60 = 1000 (1.09)30

= 1,000 13.267678

= 13,267.68

FVAge 60 = PVAge 40 (1 + i)Years until age 60

FVAge 60 = 1000 (1.12)20

= 1,000 9.64629

= 9,646.29

The investment of $1,000 at age 30 yields more money at age 60, even though the interest

rate is lower. This illustrates the importance of starting to invest earlier in life.

LG2

4-34 Future Value At age 25 you invest $1,500 that earns 8 percent each year. At age 40

you invest $1,500 that earns 11 percent per year. In which case would you have more

money at age 65?

FVAge 65 = PVAge 25 (1 + i)Years until age 60

FVAge 65 = 1,500 (1.08)40

= 1,500 21.7245215

= 32,586.78

4-9

Chapter 4 Solutions

FVAge 65 = 1000 (1.11)25

= 1,500 13.5854638

= 20,378.20

The investment of $1,500 at age 25 yields more money at age 65, even though the interest

rate is lower. This illustrates the importance of starting to invest earlier in life.

LG7

4-35 Solving for Rates You invested $2,000 in the stock market one year ago. Today, the

investment is valued at $1,500. What return did you earn? What return would you need

to get next year to break even overall?

FVN = PV (1 + i)N

1,500 = 2,000 (1 + i)1

(1 + i) = 1,500/2,000

i = (0.75) -1 = 0.25, or 25% (first year return is negative)

FVN = PV (1 + i)N

2,000 = 1,500 (1 + i)1

(1 + i) = 2,000/1,500

i = (2/1.5) -1 = 0.3333 or 33.33%

(second year return needs to be higher to compensate for the loss)

LG7

4-36 Solving for Rates You invested $3,000 in the stock market one year ago. Today, the

investment is valued at $3,500. What return did you earn? What return would you suffer

next year for your investment to be valued at the original $3,000?

FVN = PV (1 + i)N

3,500 = 3,000 (1 + i)1

(1 + i) = 3,500/3,000

i = (35/30) -1 = 0.1667 or 16.67% (first year return is positive)

FVN = PV (1 + i)N

3,000 = 3,500 (1 + i)1

(1 + i) = 3,000/3,500

i = (30/35) -1 = -0.143 or 14.3%

(second year return is negative)

LG7

4-37 Solving for Rates What annual rate of return is earned on a $4,000 investment made

in year 2 when it grows to $7,000 by the end of year six?

FVN = PV (1 + i)N

7,000 = 4,000 (1 + i)4

(1 + i) 4 = 7,000/4,000

4-10

Chapter 4 Solutions

LG7

4-38 Solving for Rates What annual rate of return is implied on a $2,500 loan taken next

year when $3,500 must be repaid in year 4?

FVN = PV (1 + i)N

3,500 = 2,500 (1 + i)(4-1)

(1 + i)3 = 3,500/2,500

i = (1.40) (1/3) - 1 = 0.1187 or 11.87%

(note, this is from the lenders perspective)

LG2&4

4-39 General TVM Ten years ago, Hailey invested $2,000 and locked in a 9 percent

annual interest rate for 30 years (end 20 years from now). Aidan can make a twenty year

investment today and lock in a 10 percent interest rate. How much money should he

invest now in order to have the same amount of money in 20 years as Hailey?

First determine how much Hailey will have.

FV30 = PV (1 + i)30

FV30 = 2,000 (1 + 0.09)30

= 2,000 13.26757847

= 26,535.36 (Haileys FV in 30 years)

So Aidan will have to deposit:

PV = FV/(1+i)N

PV = 26,535.36/(1+0.10)20

= 26,535.36/0.148643628 = 3,944.31

LG5

4-40 Moving Cash Flows You are scheduled to receive a $500 cash flow in one year, a

$1,000 cash flow in two years, and pay a $800 payment in three years. If interest rates are

10 percent per year, what is the combined present value of these cash flows?

The timeline of this problem is

Cash Flow

Period 0

500

1

1000

10%

PV = 500/(1+0.10) = 454.55

Then discount the $1000 to year 0:

PV = 1000/(1+0.10)2 = 826.45

Discount the -$800 to year 0:

PV = -800/(1+0.10)3 = -601.05

Now sum up the cash flows:

4-11

-800

3 years

Chapter 4 Solutions

4-41 Excel Problem Oil prices have increased a great deal in the last decade. The table

below shows the average oil price for each year since 1949. Many companies use oil

products as a resource in their own business operations (like airline firms and

manufacturers of plastic products). Managers of these firms will keep a close watch on

how rising oil prices will impact their costs. The interest rate in the PV/FV equations can

also be interpreted as a growth rate in sales, costs, profits, etc. (see Example 4-5).

Average Oil Prices

Year

1949

1950

1951

1952

1953

1954

1955

1956

1957

1958

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

per

barrel

$2.54

$2.51

$2.53

$2.53

$2.68

$2.78

$2.77

$2.79

$3.09

$3.01

$2.90

$2.88

$2.89

$2.90

$2.89

$2.88

$2.86

$2.88

$2.92

$2.94

Year

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

per

barrel

$3.09

$3.18

$3.39

$3.39

$3.89

$6.87

$7.67

$8.19

$8.57

$9.00

$12.64

$21.59

$31.77

$28.52

$26.19

$25.88

$24.09

$12.51

$15.40

$12.58

Year

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

per barrel

$15.86

$20.03

$16.54

$15.99

$14.25

$13.19

$14.62

$18.46

$17.23

$10.87

$15.56

$26.72

$21.84

$22.51

$27.54

$38.93

$46.47

$58.30

$64.67

a. Using the 1949 oil price and the 1968 oil price, compute the annual growth rate in

oil prices during those 19 years.

=RATE(19,0,-2.54,2.94) = 0.77%

b. Compute the annual growth rate between 1969 and 1988 and between 1989 and

2007.

=RATE(19,0,-3.09,12.58) = 7.67% for 1969 to 1988

=RATE(18,0,-15.86,64.67) = 8.12% for 1989 to 2007

4-12

Chapter 4 Solutions

c. Given the price of oil in 2007 and your computed growth rate between 1989 and

2007, compute the future price of oil in 2010, 2015, and 2020.

=FV(8.12%,3,0,64.67,0) = 81.74 in 2010

=FV(8.12%,8,0,64.67,0) = 120.78 in 2015

=FV(8.12%,13,0,64.67,0) = 178.46 in 2020

Research It!

Stock Market Returns

What kind of returns might you expect in the stock market? One way to measure how the

stock market has performed is to examine the rate of return of the S&P 500 Index. To see

historical returns of the S&P 500 Index, go to Standard & Poors web site at

www2.standardandpoors.com. Click on Indices in the side menu and then View Total

Return under the S&P 500 title. Lastly, scroll down and click the link S&P 500

historical returns. This opens an Excel spreadsheet of returns over various periods.

Examine the 1 year, 5 year, and 10 year total returns over time. What do you

conclude about the returns during each of these periods?

SOLUTION: The actual data shown will depend on the date the exercise is conducted.

However, the top portion may look like:

STANDARD & POOR'S INDEX SERVICES

S&P 500 MONTHLY RETURNS, OCTOBER 31, 2007

1 MONTH

MONTH OF

12 MONTH

PRICE

PRICE

1 MONTH

3MONTH

6MONTH

1 YEAR

3 YEAR

5 YEARS

10 YEARS

TOTAL

TOTAL

CLOSE

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

RETURN

RETURN

10/2007

1549.38

22.63

1.48%

6.47%

4.52%

12.44%

37.09%

74.92%

69.40%

1.59%

14.56%

09/2007

1526.75

52.76

3.58%

1.56%

7.45%

14.29%

36.98%

87.27%

61.17%

3.74%

16.44%

08/2007

1473.99

18.72

1.29%

-3.70%

4.77%

13.05%

33.48%

60.90%

63.87%

1.50%

15.13%

07/2007

1455.27

-48.08

-3.20%

-1.83%

1.18%

13.99%

32.09%

59.64%

52.49%

-3.10%

16.13%

06/2007

1503.35

-27.27

-1.78%

5.81%

6.00%

18.36%

31.78%

51.88%

69.84%

-1.66%

20.59%

The one year total returns are highly volatile. They can be very large and positive and

very large and negative. The total return for five year periods are much less volatile, but

can still be quite negative during some periods. The total return for ten year periods are

never negative.

4-13

Chapter 4 Solutions

Investing in Gold

People have had a fascination with gold for thousands of years. Archaeologists have

discovered gold jewelry in Southern Iraq dating to 3000 BC, and gold ornaments in Peru

dating to 1200 BC. The ancient Egyptians were masters in the use of gold for jewelry,

ornaments, and economic exchange. By 1000 BC, squares of gold were a legal form of

money in China. The Romans issued a popular gold coin called the Aureus (aureus is the

Latin word for gold). By 1100 AD, gold coins had been issued by several European

countries. Gold has been a highly sought after asset all over the world and has always

retained at least some economic value over thousands of years.

The United States has had a very chaotic history with gold. For example, in the

Great Depression, President Franklin D. Roosevelt banned the export of gold and ordered

U.S. citizens to hand in all the gold they possessed. It was not until the end of 1974 that

the ban on gold ownership by U.S. citizens was lifted. By 1986, the U.S. governments

attitude on gold ownership had completely turned around, as evidenced by the resumption

of the U.S. Mints production of gold coins with the American Eagle. However, U.S.

investors have little more than 30 years of gold-investing experience. Figure 4.5 shows

how the price of gold per Troy ounce has changed since 1974.

Figure 4.5 December Gold Prices Since 1974

4-14

Chapter 4 Solutions

These end-of-December prices do not illustrate the true magnitude of the price

bubble in gold prices that occurred in 1980.The price of gold increased from $512 at the

end of 1979 to a top of $870 on January 21, 1980. The subsequent crash in the price of

gold was just as spectacular. The annual returns of gold are shown in Table 4.5. Gold

prices have been very volatile, increasing dramatically for one or two years and then

experiencing significant declines the next year or two.

Table 4.5 Annual Gold Returns Since 1975

Year

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

Annual

Gold Return

-19.86%

-4.10%

22.64%

37.01%

126.55%

15.19%

-32.60%

14.94%

-16.31%

-19.19%

5.68%

21.31%

22.21%

-15.26%

-2.84%

-1.47%

-10.07%

Year

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Annual

Gold Return

-5.75%

17.68%

-2.17%

0.98%

-4.59%

-21.41%

-0.83%

0.85%

-5.44%

0.75%

25.57%

19.89%

4.65%

17.77%

23.20%

31.92%

a. Compute the rate of return in gold prices that occurred during the three weeks between

the last day of 1979 and the January 21, 1980 top.

SOLUTION: solve for i, 870 = 512 (1 + i)

i = 870/512 1 = 0.6992 = 69.92%

b. By the end of 1980, gold had dropped to $589.75 per Troy ounce. Compute the rate of

return from the top to the end of 1980.

SOLUTION: solve for i, 589.75 = 870 (1 + i)

i = 589.75/870 1 = -0.3221 = -32.22%

4-15

Chapter 4 Solutions

c. Imagine that you invested $1,000 in gold at the end of 1999. Use the returns in Table

4.5 to determine the value of the investment at the end of 2007.

SOLUTION:

Year

1999

2000

2001

2002

2003

2004

2005

2006

2007

Annual

Gold

Return

0.85%

-5.44%

0.75%

25.57%

19.89%

4.65%

17.77%

23.20%

31.92%

Investment

Factor

0.9456

1.0075

1.2557

1.1989

1.0465

1.1777

1.2320

1.3192

4-16

Value

1,000.00

945.60

952.69

1,196.30

1,434.24

1,500.93

1,767.65

2,177.74

2,872.87

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