Finance Quiz – 1; 2015

Question 1 (Marks 2.5)

X wants to save for higher education of his son. He estimates that college education expenses will be Rs.10 lakhs per year for 4 years when his son joins engineering college after 15 years. The first instalment of fees is due at the time of joining. He expects annual interest rate of 8%. How much money should he deposit in the bank each year for next 15 years, assume deposit at end of the year, to take care of his son’s college education.

If he saves A,

Then A* FVIFA( 8, 15years) = 10,00,000 *PVIFA (8 %, 4 Years) (1.08)

A = 121,980 * 1.08 = 131,738

Question 2 (Marks 1 +3+1)

Y has Rs.2,50,000 in the bank as savings on Dec 31, 2015. He is 50 years old and expects to work for 10 more years. He expects to make a return of 5% on his savings. Once he retires, he would like to withdraw Rs.80,000 a year for the next 25 years starting from Dec 31, 2026.

a) How much would he need in the bank on Dec 31, 2025 to be able to do this? b) How much of his income would he need to save each year for the next 10 years to be able

to afford the planned withdrawals of Rs.80,000 after the 10th year? c) If interest rates after 10 years fall to 4%, how much will Y have to lower his yearly

withdrawal?

He needs in the bank 80,000 * PVIFA ( 5%, 25) = 11,27,520

After 10 years his saving would equal an amount 2,50,000 * FVIF ( 5%, 10) = 4,07,250

Shortfall = 720,270; He would have to save an amount such that A*FVIFA( 5%, 10 ) = 720,270

A= 57,264.27 each year

His withdrawal for 25 years @ 4% would be W such that W * PVIFA (4%, 25) = 11,27,520

So, W = 72,175, so a drop of Rs.7,825 in amount he can withdraw

Question3 ( Marks 2.5)

Bond A has a coupon rate of 10% and yield to maturity of 10%. Bond B is a zero coupon bond. If bonds A and B have the same price and the same face values, what is the yield to maturity of bond B? When bonds are trading at par, YTM = Coupon Rate; Hence ZERO