I.

TIME VALUE OF MONEY

PORTFOLIO

 $180,000
 $16,200 in interest per year or $1,350 a month
 Nominal interest rate is 9%
 Real interest rate is 4.8% 1.09/1.04 1.048-1

SOCIAL SECURITY

 Receive $750 a month, which is adjusted for inflation or $9,000 annually

 This amount will stay the same, therefore, having a real interest rate of 0%

SAVINGS ACCOUNT

 $12,000
 Nominal interest rate 5%
 Real interest rate is .96% 1.05/1.04 = 1.0096 - 1

Living expenses are $1,500 a month plus $500 traveling expenses

With monthly expenses at $2,000 and Alfred receiving $750 in Social Security, he only has
to worry about covering $1250 of expenses on his own through the investment portfolio ($2000 -
$750 = $1250).

For the first year of retirement Alfred Road can safely use the interest from his portfolio to
cover all of his expenses per month. This is because inflation has not affected the interest rate yet,
so the nominal and real interests are the same. He will receive the full $1,350 from his portfolio
which will cover the $1250 of expenses after Social Security is used. For the first year, he will be
able to safely spend just the interest earned from the portfolio without having to spend any of the
principle.

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II. VALUING BONDS – CASE STUDY

A.
MICROSOFT

 n= 30 years
 Par value = $1,000
 Coupon interest = 5.25%
 Rate = 5%

Vb = PV of interest + PV of par
= I(PVIF A 6%, 30) + PAR (PVIF 6%, 30)
= 52.5 (13.765) + 1,000 (0.174)
= $889.78

GE CAPITAL

 n= 10 years
 Par value = $1,000 Coupon interest = 4.25% Rate = 8%

Vb = PV of interest + PV of par
= I(PVIF A 8%, 10) + par (PVIF 8%, 10)
= 42.5 (6.710) + 1,000 (0.463)
= $748.18

MORGAN STANLEY

 n= 5 years
 Par value = $1100
 Coupon interest = 4.75%
 Rate = 10%

Vb = PV of interest + PV of par
= I(PVIF A 10%,5) + par (PVIF 10%, 5)
= 47.5 (3.791) + 1,000 (0.621)
= $801.07

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B.

C.
a. INCREASED 2% POINTS MICROSOFT

• When rd= 6% ; Vb= $889.78

Vb = PV of interest + PV of par

= I (PVIF A 2%, 30) + par (PVIF 2%, 30)

= 52.5 (22.396) + 1,000 (0.552)

= $1,727.29

• When rd = 2%; Vb = $1,215.83

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GE CAPITAL

• When rd= 8% ; Vb= $748.18

Vb = PV of interest + PV of par

= I(PVIF A 2%, 10) + par (PVIF 2%, 10)

= 42.5 (5.983) + 1,000 (0.820)

= $1,201.78

• When rd = 2%; Vb = $1,201.78

MORGAN STANLEY

• When rd= 10%; Vb= $801.07

Vb = PV of interest + PV of par

= I(PVIF A 2%, 5) + par (PVIF 2%, 5)

= 47.5 (4.713) + 1,000 (0.906)

= $1,129.87

• When rd = 2% ; Vb = $1,201.78

b. DECREASED 2%

MICROSOFT

• When rd= 6% ; Vb= $889.78

Vb = PV of interest + PV of par
= I (PVIF A 4%, 30) + par (PVIF 4%, 30)
= 52.5 (17.292) + 1000 (0.308)
= $1,215.83
• When rd = 4% ; Vb = $1,215.83

GE CAPITAL

• When rd= 8%; Vb= $748.18

Vb = PV of interest + PV of par
= I(PVIF A 6%, 10) + par (PVIF 6%, 10)
= 42.5 (7.360) + 1,000 (0.558)
= $870.80
• When rd = 6%; Vb = $870.80

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 MORGAN STANLEY

• When rd= 10%; Vb= $801.07

Vb =PV of interest + PV of par

= I(PVIF A 8%, 5) + par (PVIF 8%, 5)
= 47.5 (3.993) + 1,000 (0.681)
= $870.67
• When rd = 8%; Vb = $870.67

D.
• According to the equations above, the value of a bond falls with an increase in
return, and there is an inverse connection between bond value and necessary return of investors.

E.
• No. Since they are overvalued

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