Assignment 1 1

ASSIGNMENT 1

NGUYEN NHAT PHUONG PHAN (ID: 222203463)

THI MY LINH TRUONG (ID: 222458773)

RICHARD STEVENS (ID: 223044792)

SEBASTIAN DAVIES (ID: 223152635)

Course: Fundamental of Finance (MAF101)

Unit Chair: Dr. Vincent Xiang

Faculty of Business and Law, Deakin University

Burwood, 3125, Victoria

17/1/2023

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Table of Content:

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Question 1:

a) The actual proportion of the retirement savings at the beginning of the first year of Nicole:

X: Total account balance at the retirement date

Y: Spending ratio of the 1st year

Spending amount of year 1: X*Y

Spending amount of year 2: X*Y*(1.03)/1.05)

Spending amount of year 3: X*Y*(1.030^2/1.05^2)

…..

Spending amount of year 25: X*Y*(1.03^24)/(1.05^24)

=> Total spending in 25 years:

XY+XY[1.03/1,05]+XY[1.03^2/1.05^2]+XY[1.03^3/1.05^3]+...+XY[1.03^24/1.05^24] = X

=> XY[1+(1.03/1.05) + (1.03^2/1.05^2) + (1.03^3/1.05^3)+....(1.03^24/1.05^24)] = X

=> Y[1+(1.03/1.05) + (1.03^2/1.05^2) + (1.03^3/1.05^3)+....(1.03^24/1.05^24)] = 1

=> Y = 0.049 = 4.9%

The amount of money Nicole needs to save by the time she retires:

10^5/4.9% = 2,040,816.33

b)

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Question 2:

Initial loan (Loan A):

Principal = $300,000
Rate = 0.005 (6%/12)
Periods = 36 (3*12)
(Monthly) Payments = $9,126.58 (=PMT(0.005,36,-300000))
Total Payments = $109,518.97 (one year of payments = Payments*12)

New loan (Loan B):

Principal = $205,921.83 (=PV(0.005, 24, -9,126.58))

Rate = 0.0025 (3%/12)
Periods = 24 (2*12)
(Monthly) Payments = $8,850.77 (=PMT(0.0025,24,-9,126.58))
Total Payments = $212,418.48 (Loan B Monthly Payments*24)

Total Interest Payment with only Loan A = ($9,126.58*36 = $328,556.92)

Total Interest Payment with Loan A & Loan B = ($9,126.58*12 + $8,850.77*24 = $321,937.45)
Monthly repayment saved = $275.81 (Payments of Loan A – Payments of Loan B)
Total Interest Payment saved = $6,619.47 (Total Interest Payment with only Loan A – Total
Interest Payment with Loan A & Loan B)

If John were to refinance his loan with the new rate, he would save $275.81 on his monthly
interest payments and $6,619.47 on his total interest payments.

Working steps:
1. Frequency alignment of data (rate/periods)
2. Use PMT excel function to find Loan A payments (=PMT(0.05,36,300,000)) =
$9,126.58)

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3. Multiply Loan A payments by 12 to get one year of Loan A payments ($9,126.58*12

= $109,518.97)
4. Use PV function to find remaining balance from Loan A to be applied to Loan B
(=PV(0.005, 24, $9,126.58) = $205,921.83)
5. Use PMT excel function to find Loan B payments (=PMT(0.0025, 24, $205,921.83) =
$8,850.77)
6. Multiply Loan B payments by 24 (2 years*12) to get Loan B total interest payments
($8,850.77*24 = $212,418.48)
7. Add total of Loan A payments by total of Loan B payments to get total interest
payments ($109,518.97 + $212,418.48 = $321,937.45)
8. Deduct Loan A monthly payments from Loan B monthly payments to get monthly
payment amount saved ($9,126.58 - $8,850.77= $275.81)
9. Multiply Loan A by 36 (3 years*12) to get total interest payment of Loan A =
($9,126.58*36 = $328,556.92)
10. Deduct total interest payment of Loan A with total interest payments to get total
interest saved = ($328,556.92 - $321,937.45 = $6,619.47)

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Question 3a)

The S&P 500 and ASX 200 are two completely different indices operating in two completely different
jurisdictions that had different approaches to the pandemic. Each jurisdiction had different responses to
lockdown and fiscal stimulus to keep their economies running. The S&P 500 is a market index tracking
the performance of the top 500 companies listed on stock exchanges in the US and is composed mainly
of Information Technology and Health Care stocks. The ASX 200 is a market index tracking the
performance of the top 200 companies listed on the Australian Stock Exchange and is composed mainly
of Mining and Financial stocks.

The RBA lowered the cash rate to ‘0.25 per cent in March 2020, and then to 0.1 per cent in November
2020’ (Reserve Bank of Australia, 2020) to attempt to increase the cash flow of businesses and
households. The RBA also began a Government Bond purchase program in November 2020, to help
‘lower the structure of interest rates in Australia’ (Reserve Bank of Australia, 2020). For banks, the RBA
lowering the cash rates, means banks lower their interest rates. While this entices the population to
borrow more money, the bank receives less back in interest from these loans, ultimately affecting their
net interest margins. This may cause a decrease in the share price of banks, which in turn causes the
ASX200 index to decrease with the banks making up a decent portion of the index.

The tightening of supply chains around the world due to Covid, impacted the mining sector in Australia,
which makes up a solid part of the ASX200. With these supply chain blockages and China going into total
lockdown, our Iron Ore production was not creating as much money as usual, causing mining stocks to
decrease in price. Furthermore, production in our mines was slowed right down as they could not get fly
in fly out workers, who make up the majority of the workforce in the mines. Ultimately affecting the
ASX200’s index.

The S&P 500’s index is mainly carried by the Information Technology and Healthcare sectors. This meant
the S&P 500 could almost thrive during Covid, which is proven by the increased return of 15% between
February 2020 and October 2022. Due to people being locked down and working from home, companies
such as Microsoft, Netflix, Amazon, and Zoom were bound to increase, due to the increased use of these
products not just in the US but all around the globe. These stocks accounted ‘for a fifth of the entire
index’s market capitalisation’ ([http://www.ft.com,n.d]www.ft.com,n.d.).

The healthcare sector also makes up a lot of the market capitalisation of the S&P 500. The pandemic
obviously highlighted the healthcare sector, with millions around the world needing the hospital due to
symptoms and problems. For example, Johnson and Johnson have a massive weighting in S&P 500 and
created a vaccine during the pandemic resulting in an increased share price. Other pharmaceutical
companies were also creating vaccines and hence rallying such as Moderna and Pfizer.

Lastly, the S&P 500 was able to outperform the ASX200 because of the inflow into the US market. Due to
the Australian market only making up 2% of the global market, it does not reach as many investors as
the S&P 500 does.

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3b)

For an investor, stocks and bonds aren’t often a good hedge to inflation in most cases, due to higher
inflation having a major impact on input costs. A way that high inflation is controlled is by reducing
consumer spending and slowing down the economy. This is achieved by having central banks around the
world increasing interest rates. In doing so, consumers will stop spending so much as receiving loans
from banks will need to be paid back with higher interest than usual. This has a negative impact on
stocks and bonds.

Regarding bonds, rising interest rates have a negative correlation with its price. This is due to new bonds
paying investors higher rates than any existing bonds, with the ‘older bonds becoming less valuable’
(Pacific Investment Management Company LLC, n.d.) as the coupon payments are lower than any new
bonds within the market, meaning the capital value of older bonds will decrease.

Regarding stocks, rising interest rates can heavily impact companies. Companies finance operations with
either debt or equity capital. Businesses that are in debt will have higher costs when interest rates rise
negatively impacting their balance sheet thus causing their stock to decrease, with debt rising as well as
performance decreasing. With the RBA also continuously increasing interest rates, this can result in less
capital growth potential for stocks. With businesses and subsequently their share price performing
worse during high inflation, this affects the dividends for shareholders, which will cause further
decreases, with shareholders selling shares come the ex-dividend date.

Investing in some companies that can pass on costs and protect their margins, will perform well and act
as a hedge against inflation. Companies that have little to no debt, a good cash flow and good balance
sheet will still be able to perform well during inflation as they do not have the added cost to service their
increased debt. The chairman and CEO of Berkshire Hathaway, Warren Buffett stated that during high
inflation the best businesses to invest in are those ‘that you buy once and then don’t have to keep
making capital investments’ (Wolfson, n.d.), like in real estate for example, as you can buy that once and
that will rise in value through inflation.

Ultimately, many investors pull back on their investments and spending during times of high inflation.
Money is also needed more, so shares are sold to compensate for prices rising for just about everything.
Unfortunately, stocks and bonds don’t act as a very good hedge against inflation unless the businesses
are prepared for it to happen.

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References:

1. Pacific Investment Management Company LLC. (n.d.). How do rates affect bond performance? |
PIMCO. [online] Available at: https://www.pimco.com.au/en-au/marketintelligence/navigating-
interest-rates/how-do-rates-affect-bond-performance/.
2. Reserve Bank of Australia (2020). Supporting the Economy and Financial System in Response to
COVID-19. [online] Reserve Bank of Australia. Available at: https://www.rba.gov.au/covid-19.
3. Wolfson, A. (n.d.). These are the types of companies Warren Buffett says you should invest in
during times of inflation. [online] MarketWatch. Available at:
https://www.marketwatch.com/picks/these-are-the-types-of-companies-warren-buffett-says-
you-should-invest-in-during-times-of-inflation-01633548517.
4. www.ft.com. (n.d.). Subscribe to read | Financial Times. [online] Available at:
https://www.ft.com/content/d2e09235-b28e-438d-9b55-0e6bab7ac8ec

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