University of Connecticut

Department of Finance
Financial Management - FNCE5101
Summer 2012
Prof. John D. Knopf
Assignment 1: SOLUTIONS
1. You deposit $1,000 in the bank today and your annual interest rate is 10% compounded every
minute. How much money will you have in 205 days and 3 hours?
Minutes in 205 days and 3 days = 205 * 24 * 60 + 3*60 = 295,380
Interest per minute = Annual rate / minutes per year = .10 / (365*24*60) = 0.0000001903
Money = 1,000 (1+ 0.0000001903)295380 = 1,057.81

2. You want to buy a car in five years and a boat in ten years. Today, the car and boat cost
$5,000 and $10,000, respectively. The price of the boat and car will grow by 3% each year.
How much money do you need to put away each year (equal payments at the end of the year)
for the next three years, to have enough money saved to buy the boat and car? You will
receive 10% interest compounded annually.
Car Cost Year 5: 5,000(1+.03)5 = 5,796.37
Boat Cost Year 10: 10,000(1+.03)10 = 13,439.16
Money needed at time 3 for Car: 5,796.375 / (1+.10)2 = 4,790.393
Money needed at time 3 for Boat: 13,439.1610 / (1+.10)7 = 6,896.423
Money needed at time 3 for Car and Boat: 4,790.39 + 6,896.42 = 11,686.81
FVA = PMT * [(1+r)T 1 ] / r
11,686.81 = PMT * [(1+.10)3] / .10; PMT = 3,530.76
3. You are the agent for Alex Rodriguez who wants to renegotiate his contract with the New
York Yankees. You are working on two possible three-year deals. Contract A pays
$25,000,000, $30,000,000, and $35,000,000 over the next three years. Contract B hasnt
been entirely settled. You have agreed to $20,000,000 and $20,000,000 for the first two
years. How much must A-Rod get the third year on Contract B to have the same present
value as Contract A? Assume that A-Rods required rate of return is 10%.
In Millions:
25/(1+.10)1 + 30/(1+.10)2 + 35/(1+.10)3 = 20/(1+.10)1 + 20/(1+.10)2 + X/(1+.10)3
X = 52.05 million

4. You can afford to pay $2,000 per month on a ten-year loan. You will pay 10% interest
compounded monthly.
a. How much can you borrow?
1

1 (1 r )t
PVA C
r

PVA = 2,000[(1- 1/(1+.1/12)10*12)/.10/12] = 151,342.33

b. How much total interest will you pay?
120*2,000 - 151,342.33 = 88,657.67
c. How much interest will you pay the second month?

Period
1
2

Principal
$151,342.00
$150,603.19

Payment
$2,000.00
$2,000.00

Interest
$1,261.18
$1,255.03

Principal
Payment
$738.81
$744.97

5. Assume that the one-year discount rate is 3.8%, two-year discount rate is 4%, and the
three-year discount rate is 4.5%. There is a three-year bond that pays an annual coupon
of C and 1000 at the end of the third year. If the current price of the bond is $975, what is
the annual coupon?
975 = C/(1+.038)1 + C/(1+.04)2 + C/(1+.045)3+1,000/(1+.045)3
C = 35.71
6. Consider a bond with four years to maturity that has a 9.25% coupon rate. The current
market interest rate is 10%. Assume the market rate falls 10% to 9%?
a. How many dollars will the bond price increase?
1

1
(1 r) t
Bond Value C
r

t
(1 r)

Coupon = 9.25%, r = 10%: BV = 92.50[(1-1/(1+.10)4) /.10] + 1,000 / (1+.10)4 = 976.23

Coupon = 9.25%, r = 9%: BV = 92.50[(1-1/(1+.09)4) /.09] + 1,000 / (1+.09)4 = 1,008.10
Price Increase: 1,008.10 976.23 = 31.87
b. What percent will the bond price increase?
Percent Increase = (1,008.10 976.23) / 976.23 = 3.26%