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IP1 - Grace Version

Discussion in 'Financial Planning' started by SaraElise, 6th Jul, 2011.

  1. SaraElise

    SaraElise Member

    Joined:
    6th Jul, 2011
    Posts:
    5
    Location:
    Adelaide, SA
    Hi Everyone,

    I am currently trying to finish the IP1 assignment.

    I am really stuck on question 2B:
    "How prices of fixed interest investments can change, illustrating the main concepts by calculating the purchase price of a 10-year government bond parcel with the following features:
     three full years remaining until maturity
     the bond’s coupon rate is 6.95% per annum, paid half-yearly
     prevailing market interest rate is 7.20% per annum
     parcel price of $100."

    I am not a mathemtical person at all and really need help with the equation and how to illustrate how prices change.

    I am very good at how to answer questions and the text detail if someone needs help on that but I really need help with the above calculation.

    Thank you :)
     
  2. beejay89

    beejay89 Member

    Joined:
    5th Jul, 2011
    Posts:
    5
    Location:
    Yeppoon, QLD
    - Long-term interest rate securities can provide a known yield to maturity however, if the interest rate moves, then that means that the resale market value of these securities could change.
    - Eg: if interest rates move up – (on the secondary market) the capital price of the bond will fall and will allow the bond to be bought for less than its face value.
    - If interest rates fall – capital price of the bond will rise and it will be bought at a premium (more than its face value).

    The total value of the bond will equal the Face Value plus the present Value. We already know the face value is $100.00 so to find the present value, we calculate the present value at each coupon payment, and add all of these to the face value at the last coupon payment.

    P = C / (1+i)n
    Where:
    P = Present Value (Price)
    C= Coupon Value (interest payments)
    N = Number of Coupons
    I = prevailing market interest rate divided 200
    Therefore:
    P = What we need to find
    C = $3.475 (as the coupon rate = 6.75% of $100 per year ($6.75) paid every half year (so $6.75/2 = $3.475)
    N= 6 (as there are 3 years until maturity and it is paid every half year. So 2 payments for 3 years = 6)
    i = 0.036 (7.2%/2)
    Hence:
    P = (3.475/(1+0.036)1) + (3.475/(1+0.036)2) + (3.475/(1+0.036)3) + (3.475/(1+0.036)4) + (3.475/(1+0.036)5) +
    ((3.475+/(1+0.036)6)+100)
    = 3.475/1.036 + 3.475/1.073 + 3.475/1.111 + 3.475/1.151 + 3.475/1.193 + ((3.475/1.1236) + 100)
    = 3.354 + 3.238 + 3.127 + 3.019 + 2.912 + 83.717
    = $99.367



    Does this help??
    :):)
     
  3. SaraElise

    SaraElise Member

    Joined:
    6th Jul, 2011
    Posts:
    5
    Location:
    Adelaide, SA
    Thank you!

    Hi beejay89
    Thank you so so much for your help on this! I really apprecitate it.
    I feel alot better about tackling this question now :p
     
  4. beejay89

    beejay89 Member

    Joined:
    5th Jul, 2011
    Posts:
    5
    Location:
    Yeppoon, QLD
    You're very welcome : )... I've received alot of help with my DFP and i'm just paying it forward... Hope u do well!!

    Belinda :)