- 20 Marks
FM – July 2023 – L2 – Q3 – Discounted cash flow | Simple interest and compound interest
Compute the maturity value of a loan, determine the size of quarterly sinking fund deposits, and compare annuity due with ordinary annuity.
Question
a) Osiadan Contractors Ltd plans to construct housing units in the Kpone-Katamanso District of Ghana for sale to young professionals. It has obtained a US$4 million loan facility from the International Finance Corporation (IFC). The total principal granted will be released in two equal tranches: the first tranche to be released now and the second tranche at the beginning of the fourth year. Interest will be charged on the loan at 12% per annum with semi-annual compounding. The total principal granted plus the total interest is to be paid at the end of the duration of the loan in six years’ time.
To raise money toward the settlement of the maturity value of the loan, Osiadan Contractors Ltd plans to establish a sinking fund by which it will deposit equal amounts of U.S. dollars at the beginning of every quarter starting from the third year until the end of the loan duration. The dollar deposits will be invested at 8% per annum with quarterly compounding.
Required:
i) Compute the maturity value of the loan at the end of six years. (3 marks)
ii) Compute the size of the quarterly deposits to be invested in the sinking fund to raise the amount needed to settle the maturity value of the loan. (4 marks)
iii) Compare and contrast annuity due and ordinary annuity. (3 marks)
b) Klessy Beverages Inc (Klessy), an American malt drink producer, imports barley from Australia and pays for the import in Australian dollars. It has bought a consignment of barley with an invoice value of AUD2.5 million, and payment is due next month. The exchange rate between the United States dollar (USD) and the Australian dollar (AUD) is currently trading at USD0.7265/AUD. The Managers of Klessy fear that the Australian dollar may strengthen against the US dollar. The Treasury Manager has recommended using currency options to address the potential currency risk.
Below are the CME Group’s quotations for weekly options on the Australian dollar:
| Contract Specification | Call | Put |
|---|---|---|
| Contract size | AUD100,000 | AUD100,000 |
| Premium (US$) | 0.0131 | 0.0031 |
| Strike price (US$) | 0.7275 | 0.7275 |
| Expiration | Week 4 | Week 4 |
Required:
i) Justify which option Klessy should buy considering its underlying currency exposure. (3 marks)
ii) Compute the intrinsic value of your selected option and interpret the results. (4 marks)
iii) Distinguish between option premium and option strike (or exercise) price. (3 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Annuity due, Loan maturity value, Ordinary annuity, Sinking Fund
- Level: Level 2
- Topic: Discounted cash flow, Simple interest and compound interest
- Series: JULY 2023