Question 3 - Mortgages
The sovereign debt crisis in Europe and a slowing US economy have dented consumer and business confidence in the western world. There has been an increase in talks of a possible recession in the U.S and the likely effects of it on the Canadian economy. In the midst of this, your family friend Ms. Hazel Diego and her fiancé have decided to purchase their dream home. Their dream home is listed for $900,000; if they decide to purchase the house this week they can get an additional $30,000 off the list price. They do not want to pay CMHC (Canadian Mortgage and Housing Corporation) insurance premium and have decided to make a 25% down payment (which is 5% higher than the minimum required to avoid the insurance premium).
Hazel and her fiancé follow macro events globally and have friends that work in the investment industry. Based on their own research and recommendation made by friends they feel we potentially have a banking crisis unfolding in Europe and that the US will either go into a recession or at best be in stall speed (1%-2% GDP growth) for several years. The banking crisis in Europe coupled with a recession/stall speed in the U.S will lead to a global economic slowdown and potentially reduce the demand for commodities and other services. This global slowdown can negatively affect the Canadian economy, which in turn will force the Bank of Canada to keep interest rates at current levels or do further monetary easing.
Following are the two mortgage rates offered by a local bank in Toronto that they can choose to finance their purchase:
1. 5-year fixed rate mortgage at 3.95% or
2. 5-year variable rate mortgage at prime minus 0.50%.
Hazel knows you are taking ADMS 3530 at York University and she has come to you for advice. Below are the questions she needs help with:
Questions:
a) How much will be the principal outstanding on the mortgage at the end of five years under the two options?
b) If Hazel and her fiancé decide to increase their bi-weekly payments by $50, how much sooner can they expect to be mortgage-free under both the scenarios?
Assume prime rate in Canada is 3.0%, mortgage payments are bi-weekly, amortization period is twenty-five years and interest rates stay at current levels over the next five years.
Question 4 - Bonds (20 marks)
Today is January 1, 2012. Kinder Corporation has just issued bonds at par with an effective annual yield of 8.16%, fixed semi-annual coupon payments, total face value of $100,000 ($1000 per bond), and a maturity of 8 years. The first coupon payment is due in 6 months from today.
a) Calculate the dollar amount of the first semi-annual coupon payment.
b) A year has passed, and the second semi-annual coupon payment has just been made. Kinder is concerned about having funds available to repay the face value of its bonds in 7 years’ time. (The semi-annual interest payments can be funded by the operating cash flows.) Kinder would like to invest some funds in the zero-coupon bonds of Morgan Company, having a quoted YTM of 9% (compounded semi-annually) and maturing 7 years later. What is the minimum amount (in dollars) should Kinder invest in Morgan’s zero-coupon bonds on January 1, 2013, to have sufficient funds to repay its own bonds 7 years later?
c) One more year has passed, and the fourth semi-annual coupon payment has just been made. Suppose the effective annual yield to maturity applicable to Kinder’s bonds is now 209 basis points higher than it was when the bonds were issued. If the rates are not expected to change after the second year (that is, after the increase of 209 basis points), calculate the total market value of Kinder’s bonds (in dollars) on January 1, 2014.
Question 5 - Stocks
The earnings and dividends of Greenday Credit Corporation (GCC) are expected to grow at an annual rate of 10 percent during the next two years, at 8 percent annually in the third and fourth years, and at a constant annual rate of 2.5 percent thereafter. GCC paid a dividend of $1.20 per share yesterday. The required rate of return on GCC stock is 17.5 percent.
a) What value per share would you place on the stock today?
b) Calculate the stock price two years from today, and three years from today.
c) Calculate the dividend yield, capital gains yield, and total return for year 4
Question 6 - Stocks (15 marks)
The stock of ABC Corp. has a current price of $40 based on an expected dividend of $2 per share and a required rate of return of 15%. ABC pays out 60% of its earnings as dividends.
(a) What is the expected growth rate of ABC’s stock?
(b) What will be ABC’s ROE for the upcoming year?
(c) What will be ABC’s PVGO (Present Value of growth opportunities)?
ANSWERS TO BE SOLVED IN FULL SOLUTIONS FOR BETTER UNDERSTANDING!
THANKS!
The sovereign debt crisis in Europe and a slowing US economy have dented consumer and business confidence in the western world. There has been an increase in talks of a possible recession in the U.S and the likely effects of it on the Canadian economy. In the midst of this, your family friend Ms. Hazel Diego and her fiancé have decided to purchase their dream home. Their dream home is listed for $900,000; if they decide to purchase the house this week they can get an additional $30,000 off the list price. They do not want to pay CMHC (Canadian Mortgage and Housing Corporation) insurance premium and have decided to make a 25% down payment (which is 5% higher than the minimum required to avoid the insurance premium).
Hazel and her fiancé follow macro events globally and have friends that work in the investment industry. Based on their own research and recommendation made by friends they feel we potentially have a banking crisis unfolding in Europe and that the US will either go into a recession or at best be in stall speed (1%-2% GDP growth) for several years. The banking crisis in Europe coupled with a recession/stall speed in the U.S will lead to a global economic slowdown and potentially reduce the demand for commodities and other services. This global slowdown can negatively affect the Canadian economy, which in turn will force the Bank of Canada to keep interest rates at current levels or do further monetary easing.
Following are the two mortgage rates offered by a local bank in Toronto that they can choose to finance their purchase:
1. 5-year fixed rate mortgage at 3.95% or
2. 5-year variable rate mortgage at prime minus 0.50%.
Hazel knows you are taking ADMS 3530 at York University and she has come to you for advice. Below are the questions she needs help with:
Questions:
a) How much will be the principal outstanding on the mortgage at the end of five years under the two options?
b) If Hazel and her fiancé decide to increase their bi-weekly payments by $50, how much sooner can they expect to be mortgage-free under both the scenarios?
Assume prime rate in Canada is 3.0%, mortgage payments are bi-weekly, amortization period is twenty-five years and interest rates stay at current levels over the next five years.
Question 4 - Bonds (20 marks)
Today is January 1, 2012. Kinder Corporation has just issued bonds at par with an effective annual yield of 8.16%, fixed semi-annual coupon payments, total face value of $100,000 ($1000 per bond), and a maturity of 8 years. The first coupon payment is due in 6 months from today.
a) Calculate the dollar amount of the first semi-annual coupon payment.
b) A year has passed, and the second semi-annual coupon payment has just been made. Kinder is concerned about having funds available to repay the face value of its bonds in 7 years’ time. (The semi-annual interest payments can be funded by the operating cash flows.) Kinder would like to invest some funds in the zero-coupon bonds of Morgan Company, having a quoted YTM of 9% (compounded semi-annually) and maturing 7 years later. What is the minimum amount (in dollars) should Kinder invest in Morgan’s zero-coupon bonds on January 1, 2013, to have sufficient funds to repay its own bonds 7 years later?
c) One more year has passed, and the fourth semi-annual coupon payment has just been made. Suppose the effective annual yield to maturity applicable to Kinder’s bonds is now 209 basis points higher than it was when the bonds were issued. If the rates are not expected to change after the second year (that is, after the increase of 209 basis points), calculate the total market value of Kinder’s bonds (in dollars) on January 1, 2014.
Question 5 - Stocks
The earnings and dividends of Greenday Credit Corporation (GCC) are expected to grow at an annual rate of 10 percent during the next two years, at 8 percent annually in the third and fourth years, and at a constant annual rate of 2.5 percent thereafter. GCC paid a dividend of $1.20 per share yesterday. The required rate of return on GCC stock is 17.5 percent.
a) What value per share would you place on the stock today?
b) Calculate the stock price two years from today, and three years from today.
c) Calculate the dividend yield, capital gains yield, and total return for year 4
Question 6 - Stocks (15 marks)
The stock of ABC Corp. has a current price of $40 based on an expected dividend of $2 per share and a required rate of return of 15%. ABC pays out 60% of its earnings as dividends.
(a) What is the expected growth rate of ABC’s stock?
(b) What will be ABC’s ROE for the upcoming year?
(c) What will be ABC’s PVGO (Present Value of growth opportunities)?
ANSWERS TO BE SOLVED IN FULL SOLUTIONS FOR BETTER UNDERSTANDING!
THANKS!
