Question

Question 2 (14 marks) Grace is considering selling all of her holding of stocks and putting the money into a bank account. After checking out three banks, she obtained the following information: i) Bank A alc: 24% APR with annual compounding ii) Bank Ba/e: 22% APR with semi-annual compounding iii) Bank Ca/e: 24% APR with daily compounding (360 days per year and 30 days per month) Just based on the quarterly return(Effective Quarterly Rate) of the accounts, which one would Grace prefers the most and which one the least? Answer with 2 decimal places in percentage. Question 3 (12 marks) Consider the following infinite series of cash flows, of which alternate cash flows of $9 and $5 take place between t-2 and t-26. All other cash flows, including those att0,t1 and from t-27 onwards are $5 per year with the only except of Year 47, at which the cash flow is Sl). Time(yr.) 0 1 2 3 4 5 ... 25 CF $5 $5 $9 $5 $9 $5... Suppose the effective annual rate is 5%. 26 $9 27 28 ... 45 $5 $5... $5 46 $5 47 48 49 ... $I $5 $5 ... a) Calculate the present value (att-0) of this cash flow series. (10 marks) [Hints: (1) What is the effective) 2-year rate (E2YR)? (2) Can assume the "basic" cash flows are $5 each year.] b) Is it possible to find the future of this cash flow series? Explain. (2 marks)

Answer 1

Ans.2). Effective quarterly rate (EQR) = ((1+ APR)^(1/4))-1

Bank A EQR = ((1+24%)^(1/4)) -1 = 5.53%

Bank B EQR = ((1+22%)^(1/4)) -1 = 5.10%

Bank C EQR = ((1+24%)^(1/4)) -1 = 5.53%

The least preferred would be Bank B as it has the lowest EQR. Most preferred should be Bank C as it has higher EQR and number of compoundings is higher.