Question 1

Your family recently bought a house. To buy the house, your family took a $100,000, 5-year loan with 9
percent nominal interest rate. Interest is charged yearly and all payments are made at the end of the year.
a. What would be the fixed yearly payments?
b. Prepare an amortization schedule showing breakdown of yearly principal and interest payments to settle
the loan.

Solution
According to question,
Nominal interest rate, r = 9% = 0.09
Principal borrowed, PV = $100,000
Investment period = 5 years
Principal borrowed ×r $ 100,000 × 0.09
a. Fixed yearly payment = 1−
1 = 1−
1 = $25,709.25
(1+r )n (1+ 0.09)5
b.
End of Beginning Year Loan Nominal Interest Principal End of Year
Year Principal Payment 9% Payment Principal

1 $100,000.00 $25,709.25 $9,000.00 $16,709.25 $83,290.75

2 $83,290.75 $25,709.25 $7,496.17 $18,213.08 $65,077.67
3 $65,077.67 $25,709.25 $5,897.00 $19,852.26 $45,225.41
4 $45,225.41 $25,709.25 $4,070.29 $21,638.00 $23,586.45
5 $23,586.45 $25,709.25 $2,122.19 $23,586.45 $0.00
 Question 2
Your father, who is 40, plans to retire in 15 years, and he expects to live independently for 10 years. Suppose
your father wants to have retirement income of $40,000 each year after he retires. His retirement income will
start the day he retires. He could earn 7 percent on savings during retirement period.
a. How much must your father have in his retirement account during retirement?
b. Assume, your father can earn 10 percent from now till retirement, how much must he should save each
year to meet his retirement goals?

Solution

40 years 55 years 65 years

0 15 years (working period) 15 10 years (retirement period) 25

Given information,

Retirement income (cash flows) at the beginning of each year = $40,000

Earning rate on investment during the retirement period, r = 7%

a. Since the income will start the day he retires and cash flows are all equal, it’s an annuity due.
Therefore, the amount my father must have in his retirement account during retirement

Cash flows 1
=
r
1−
((1+ r )n )
×(1+r )

$ 40,000 1
= 0.07 (
1−
( 1+ 0.07 )10 )
× ( 1+0.07 ) = $300,609.3

b. Given, earning rate on investment during working period, r = 10%

The amount he should save each year to have the anticipated amount during retirement

Future Value ×r $ 300,609 × 0.10

=
(1+r )n−1
= (1+0.10)15−1
=¿ $9461.30
 Question 3
John and Jessica are saving for their child’s education. Their daughter is currently eight years old and will be
entering college 10 years from now (t = 10). They estimated college cost would be $20,000 every year. They
expect their daughter to graduate in four years, and that all yearly college fees will be due at the beginning of
each year. Their investment account is expected to have an annual return of 12 percent.
a. What is the amount they must save for their daughter while she starts college?
b. How much cash they have to save each year to meet their child’s anticipated college costs?

Solution

8 years 18 years 22
years

0 10 years (investment period) 10 4 years (payment period) 14

Given information,

Estimated college cost that will be due at the beginning of each year (annuity due) = $20,000

Investment account is expected to have an annual return, r = 12%

a. The amount they must save for their daughter while she starts college,

Annual college cost 1

= (1− )×(1+r )
r ( 1+ r )n
$ 20,000 1
= 0.12 (1− ( 1+0.12 )4 )×(1+0.12) = $68,036.63

b. The amount of cash they have to save each year to meet their child’s anticipated college costs,

Future Value ×r $ 68,036.63 × 0.12

=
(1+r )n−1
= (1+0.12)10−1
= $3877.01
 Question 4
You intend to purchase a 10-year, $1,000 face value bond that pays coupon every 6 months with a coupon
rate 12%. If your required rate of return is 10 percent. How much should you be willing to pay for this bond?

Solution
Given information,
Face value of the bond = $1000
Required Rate of Return = 10%
Coupon Rate = 12%
Annual Coupon payment = 12% of $1000 = $120, Semiannual Coupon Payment = $120/2 = $60
Bond price = Present value of coupon payments + Present value of maturity payment
Annual Coupon Payment
m 1
= Required Rate of Return
m
1−
(
(1+
Required Rate of Return m ×n
m
) ) +

Face value
Required Rate of Return m ×n
(1+ )
m
$ 120
$ 1000
2 1
= 0.10
2 (1−
(1+
0.10 2 ×5
2
) ) + (1+
0.10 2 ×5
2
) = $1077.22
 Question 5
A bond matures in 12 years and pays an 8 percent annual coupon. The bond currently sells for $965.
a. What is the bond’s current yield?
b. What is the yield to maturity?

Solution
Given information,
Maturity period = 12 years
Coupon Rate = 8%
Coupon Payment = 8% of $1000 = $80
Bond Price = $965
We know, par value or face value of bonds is = $1000

Annual Coupon Payment $ 80

a. Bond’s current yield =
Bond Price
×100 % = $ 965
×100 % = 8.29%

Face value−Bond price(today )

Coupon Payments+
n
b. Yield to maturity = =
Face value+ Bond price(today)
2
$ 1000−$ 965
$ 80+
12
=
$ 1000+¿ 965
= 8.44%
2