MGFB10 L1/L2/L3/L4
Principle of Finance
MIDTERM EXAM

March 1, 2014
9:00AM – 11:00 AM (120 Minutes)
Prof. Syed Ahmed & Prof. Ling Cen

Last Name: _____________________ First Name:___________________________

Student # _______________________ Section # _____________________________

Instructions: Important: Students are allowed to bring calculators and a crib sheet (letter size). The crib sheet
can be only be single-sided. Only hand written crib sheets are allowed. Invigilators will take your crib sheet away if
printed, photocopied or scanned materials are found.
- Total number of questions: 4 ; Total number of pages:
- Full Mark: 100 (25 for each question)
- Write down your answers in the space provided below each question; if you need more space, you can write at the
back of the examination papers with proper indications.
- Always clearly show all steps in your calculations. Your grades will NOT be based on final solutions only.
- Always leave 4 decimals in the ($) numbers in your calculations (e.g. PMT = $10.8924) and, particularly, 6
decimals for interest rates (e.g. r = 0.078643 or 7.8643%).
- If you use a pencil while answering the exam questions, you cannot request for a re-grading after all grades are
issued.
- Good luck!

The University of Toronto's Code of Behaviour on Academic Matters applies to all University of
Toronto Scarborough students. The Code prohibits all forms of academic dishonesty including, but not
limited to, cheating, plagiarism, and the use of unauthorized aids. Students violating the Code may be
subject to penalties up to and including suspension or expulsion from the University.

For Instructors/TAs Use ONLY

Q1 Q2 Q3 Q4 Total

Management, 1265 Military Trail, Toronto, ON, M1C 1A4, Canada 1

www.utsc.utoronto.ca/mgmt 
 
Q1:

Solution

a. (1+r4month)3= (1+6%/2)2 therefore, r4month= 1.9901%

50   1  0.5% 10 
P-1 month  1     =459.2355    (459.2263 if keep 4 decimal places) 
1.9901%  0.5%   1  1.9901%  

P0= P-1 month × (1+r1month) = 461.5035 (461.4944 if keeping 4 decimal places in intermediate steps)
(8’)

b. rquarterly=(1+12%)1/4 -1 = 2.8737%

FV(4 payments in the first year)t=year 1 = 4.1758

FV (4 payments in the second year)t=year 2 = 4.2593

FV (4 payments in the third year)t=year3 = 4.3445

Therefore, the FV of 4 payments at the end of the year grows with 2% annually. We can regard that as
a growing perpetuity.

P0 = 4.1758/(12%-2%) = 41.758

(8’)

c.

1. rmonth = (1+6%/2)2/12 -1 = 0.4939%

PMT= 5948.2342

Beginning balance of 126th month = Ending balance of 125th month = PV of all future payments after
5948.2342 1
125th month = = (1  ) =825,997.2423 (825,967.4749 if keeping 4
0.4939% (1  0.4939%)360-125
decimal places in intermediate steps) (5’)

PMT
2. Principal Payment in month t =
(1  r )T t 1

PMT
Interest Payment in month t = PMT 
(1  r )T t 1

2
 
 
PMT PMT
So we are calculate the t when T t 1
> PMT 
(1  r ) (1  r )T t 1

PMT would be cancelled out in both sides, when we plug in r and T, the inequality becomes

1 1
>1-
(1  0.4939%) 360-t+1
(1  0.4939%)360-t+1

2
>1
(1  0.4939%)360-t+1

2> (1  0.4939%)360-t+1

Ln2>ln(1+0.4939%)×(361-t)

361-t<140.6986

t>220.3014

Therefore, in the 221th month, the principal payment, for the first time, exceeds the interest payment in
this mortgage. (4’)

3
 
 
Q2:

Solution:

4
 0.077706 
EAR  1    1  0.08  8% (3’)
 4 

PV of retirement needs at age 65 (5’)

 $600,000 1.08
20
FV of cost of home at age 65  $2,796,574 (2’)

 $700,000  1.08
10
FV of cost of rental property at age 65  $1,511,247 (2’)

 1 
 1 
1.08 
40

Value of rental income at age 65 $35, 000   1.08 10  $901, 052 (3’)
 0.08 
 
 

 1 
 1 
1.08 
30

Value of Pensions at age 65 $25, 000    $281, 445 (3’)

 0.08 
 
 

$150, 000 1.08   $3, 258, 678 (2’)

40
Value of Equity Fund at age 65

$120, 000 1.08   $380, 660 (2’)

15
Value of inheritance at age 65

4
 
 

SHORTFALL -$917,869

He should save

(3’)

5
 
 
Q3

Solution:

YTM C   F  P  / t 30  1000  656.82  / 40

a. 1.    0.046571
2  F  P / 2 1000  656.82  / 2
Try YTM/2 = 5%

 1 
 1 
1.05 
40

$656.82  $30    1000  $656.82

 0.05  1.05 40
 
 

Therefore YTM = 0.05 x 2 = 0.10

and Effective Yield = (1.05)2 -1 = 10.25% (9’)

 1 
 1 
1.04 
28

2. P6  $30    1000  $833.37

 0.04  1.04 28
 
 

Semiannual rate of interest on coupons reinvestment = (1.07)0.5–1 = 0.03441

 1.0344112 
FV of coupons $30    $436.59
 0.03441 
 

Annual Realized Rate of Return

1
 833.37  436.59  6
   1  0.116154  11.6154% (8’)
 656.82 

 1 
 1 15 

b. $1109.29  C 
1.07    1000
 0.07  1.07 15
 
 
= 9.107914C + 362.45

$746.84 = 9.107914C Therefore C = $82

and Current Yield = $82/1109.29 = 7.392% (8’)

6
 
 
Q4:

Solution

a. g=b×ROI=0.6×0.3=0.18 (5’)

b. Here is the cash flow chart for the first three periods (7’)

Items 1 2 3
EPS 10 10×1.18 10×1.182
Dividend 4 4×1.18 10×1.182
Retained Earnings 6 6×1.18 0
(Reinvestment)

Therefore,

4 4 1.18 10 1.182 / 0.1

P0=   = 122.6116
1.1 1.12 1.12

c: If there is no investment opportunity at all, the dividend will be 10 forever, therefore

P0=10/0.1=100 (5’)

d: The difference between (b) and (c), i.e., 22.6116, must be contributed by two reinvestments at t=1
and t=2

6  0.3
6 
NPVinvestment t=1 = 0.1 =10.9091
1.1

6 1.18  0.3
6 1.18 
NPVinvestment t=2= 0.1 =11.7025
1.12

The sum of these two numbers is exactly 22.6116 (8’)

7