Q1
John expects to retire in the next 20 years.
He has decided to create a retirement account where he will be depositing $1000
with the employer matching a similar amount. The average interest rate for the
year is expected to remain at 12%. Time
value of money can be used to calculate the amount in John’s retirement account
at the end of the 20 years. The payments are made at the end of each year. The
total amount in the account at the end of the period is called future value of
an ordinary annuity (Melicher & Norton, 2011).
Where FV=Value of the retirement account at
the end of 20 years
PMT=$2000
i=12% or 0.12
=$2,000×72.05244244
=$144,104.8849
Q2
Yield to Maturity (YTM) is the rate of return
that an investor gets if he/she was to purchase a bond at the existing market
price and hold that bond to maturity (Besley & Brigham, 2009). There is an
inverse relationship between bond coupons and bond prices. It follows from this
that the prices of the two different AAA bonds in the market reflects the
variations in coupon values. The market prices of the two bonds must,
therefore, adjust to cater for the different coupon rates. The same adjustment
operates to make the YTM of the two bonds equal at 7%.
References
Besley, S.&Brigham, E.F.(2009).Principles of Finance, Fourth Edition.Mason,OH:South- Western Cengage Learning.
Melicher, R.W. &Norton, E.A. (2011).Introduction to Finance: Markets,
Investments and Financial Management,
14th Edition. New York: John Wiley
& Sons.
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