PART 1  

Your answers to Part 1 below should show ALL relevant workings including the formulas used and the values of the variables that will be inputted into the formulas. Final answers should be correct to two decimal places. A word version of the Formula Sheet is available on the Moodle site to assist with presentation.

Question 1: An insurance company is offering a new policy. The policy is bought by a parent for a child at the child’s birth. The purchaser (the parent) makes the following six payments to the insurance company:

  First birthday:      $500  

  Second birthday: $600  

  Third birthday:     $700  

  Fourth birthday:  $800  

  Fifth birthday:      $900  

  Sixth birthday:      $1,000

After the child’s sixth birthday, no more payments are made. When the child reaches age 65, they receive $275,000. If the relevant interest rate is 11 percent for the first six years and 7 percent for all subsequent years, is the policy worth buying? 

Question 2: You have your choice of two investment accounts. Investment A is a 15-year annuity that features end-of-month $1,500 payments and has an interest rate of 8.7 percent compounded monthly. Investment B is an 8 percent compounded weekly lump-sum investment, also good for 15 years. 

How much money would you need to invest in B today for it to be worth as much as Investment A 15 years from now?

Question 3: The Blassco Corporation has two different bonds. Bond A has a face value of $30,000 and matures in 20 years.  The bond makes no payments for the first six years, then pays $800 every six months over the subsequent eight years, and finally pays $1,000 every six months over the last six years. Bond B has a face value of $30,000 and a maturity of 20 years. It makes no coupon payments over the life of the bond.  If the required return on both these bonds is 8 percent compounded semiannually, what is the current price of Bond A? Of Bond B? 

Question 4: The Delphine Co. just paid a dividend of $1.95 per share on its stock. The dividends are expected to grow at a constant rate of 6 percent per year indefinitely. If investors require an 11 percent return on Delphine Co. stock, what is the current price? What will the price be in three years?