Question

Bonds 12.14 A bond has face amount of $1000, matures in seven years, and pays $80 interest every year. To yield 6%, the price of the bond is nearest: (A) S1000 (B) $1110 (C) $1450 (D) $1560 Inflation 12.15 Ferox Engineering Company intends to sign a contract obligating it to provide bridge inspection services for five years. In return, Ferox will receive $5000 initially and $10,000 at the end of each of the five years of service. Ferox uses a 12% discount rate. If the annual inflation rate will be 4%, what is the inflation-adjusted present value of the contract? (A) S41,000 (B) $39,500 (C) $37,700 (D) $37,400 12.16 Inflation is economically advantageous for which of the following: (A) Investor who has purchased a bond. (B) Government agency that has issued bonds. (C) Company that signed a ten-year contract to sell its product at a fixed price. (D) Manufacturer that buys raw material at market price and does not stockpile it.

please show your work

Answer 1

12
a	Face amount	$1,000
b	Annual interest	$80
c	Interest rate	6%
Note: Bond should be traded now at a present value of future cash inflows
d	Present value annuity factor for Seven years (1/(1+r)^1 + 1/(1+r)^2+…....1/(1+r)^7, r=expected rate of return	5.58
e	Present value factor for seventh year 1/(1+r)^7	0.67
f	Present value (e*a+d*b)	$1,111.65
Nearest value is 1110 option B is the answer
13
a	Initial cash inflow	$5,000
b	Annual cash inflow	$10,000
c	Discount rate (r1)	12%
d	Inflation rate(r2)	4%
e	Adjusted present value factor for 1 year (1/1+r1)*1/(1+r2)	0.86
f	Adjusted present value factor for 5 years e + e^2….e^5	3.24
g	NPV (a+f*b)	$37,379.64
Option D
14	Option B is correct
	Reason
Option A is wrong	The investor who has purchased the bond at the time of redemption would get less value since the money value would be less due to redemption and to purchase same value of bonds at the time of redemption the prize would be high. Hence it is not advantagoeus to the investor
Option B is correct	Government agency issued bonds will have to redeem at fixed price even after inflation and though the current bond rates would have gone up due to inflation, still it has to redeem at the same accepted price
Option C and D is wrong	Compnay loses when it agreed to sell at a fixed price and due to inflation the prices will obviously go up but he will be still selling at low price. A company purchasing a raw material and in advance before inflation and storing it to use during inflation will be a loss to the company if it is has to purchase during inflation period at high rates