Tutorial 2: Annuities and Bonds

1. A company’s shares are currently at 85 per share, and the number of outstanding shares is
50,000. The book value of the company’s equity is 2 million (the difference between its total
assets and total liabilities in its annual accounts). What is the market to book ratio (M/B) for
this company and what can be inferred from this number?

2. Find the effective annual interest rate in each case.

Stated Annual Rate Compounding Period
12% 1 month
8% 3 months
10% 6 months

3. The €40 million lottery payment that you just won actually pays €2 million per year for 20
years. If the discount rate is 8% and the first payment comes in 1 year, what is the
present value of your winnings?

4. You want to save a part of your salary each year for your retirement. If you save 6,500 each
year and work for 45 years, how much will you savings be worth when you retire? Assume you
will earn an average return of 5.5% on your retirement savings.

5. A local bank advertises the following deal: “Pay us €100 a year for 10 years and then we will
pay you (or your beneficiaries) €100 a year forever.” Is this a good deal if the interest rate
available on other deposits is 6%?

6. Why are high inflation (well above 2%) and deflation so damaging for an economy?

Tutorial Question
You can buy a property today for €3 million and sell it in 5 years for €4 million. (You earn no
rental income on the property.)
a) If the interest rate is 8%, what is the present value of price you can sell at in 5 years?
b) Is the property investment attractive to you? Why or why not?
c) Would your answer to (b) change if you also could earn €200,000 per year rent on the
property?

Bonds:
1. a) What is the difference between the coupon and the yield to maturity of a bond?
b) Why would the coupon exceed the yield and vice versa?
c) Why is the yield on a 10y US T-bond higher than on a 10y German Government Bond
(known as a Bund)?

2. A 30-year Treasury bond is issued with a par value of $100, paying a coupon of 6% or $60
per year. If interest rates increase after the T-bond is issued, what happens to the bond’s a)
coupon rate? b) price? c) yield to maturity?

3. If a bond with par value of $1,000 and a coupon of 8% is selling at a price of $970, is the
bond’s yield to maturity more or less than 8%?

4. A bond has 8 years until maturity, a semi-annual coupon of 8%, and sells for €110. What is its
yield to maturity? (solve using excel)