FINM 2412 Financial Management for Business
Tutorial 3 Answers
Question 1
If you were offered a return of 12% EAR or 12% APR with monthly payments, which one would you
choose?
12% APR
The APR number does not include compounding, hence the effective rate would be higher.
The EAR eqv. of 12% APR is (1 + 0.12/12)^12 - 1= 12.68%
Question 2
Convert 10% APR with quarterly payments into its EAR.
(1 + 0.10 /4)^4 - 1= 10.38%
Question 3
(a) Consider a $30,000 car loan with 60 equal monthly payments, computed using a 6.75% APR
with monthly compounding. Work out the monthly payment (basically the coupon of the
annuity).
(b) After making 12 repayments on the loan above, use the present value formula to work out
the remaining balance of the loan.
Effective monthly rate = 0.0675 / 12 = 0.005625
Use the PV of annuity formula:
30,000 = X (1- 1.005625^-60) / 0.005625
X = 590.50
The monthly repayments of $590.50
After making 12 repayments, there are 48 payments left:
590.50 * (1 – 1.005625^-48) / 0.005625 = $24,779.24
1
Question 4
(a) If the yield curve is positively sloping, such that the yield to maturity of long dated zero-
coupon bonds are higher than the yield to maturity of short dated treasury bills, what does
this imply about investor expectations of future interest rates?
(b) If the yield curved inverted, what does this mean about the yield to maturity of short
maturity bonds vs. long maturity bonds? Furthermore, what does this mean about the state
of the economy?
If the yield curve is sloping up, the current expectations of future interest rates is that they will be
higher. (Pure expectations theory)
If the yield curve is inverted, the yields on short maturity bonds are higher than yields on longer
maturity bonds. An inverted yield curve is generally associated with a recession.
Question 5
You buy an apartment in Brisbane for $1,200,000. 50% of this is funded by a 20 year mortgage. The
bank charges you 4% APR compounded monthly. You pay exactly the monthly instalment suggested
by the bank. After 5 years, you sell your apartment for $1,400,000 and repay any outstanding debt
you have with the bank. How much are you left with?
Mortgage = 600,000
Effective monthly rate = 0.04 / 12 = 0.00333
Number of instalments = 20* 12 = 240
Work out the monthly instalment:
600,000 = X (1 – 1.003333^-240) / 0.003333
X = 3635.76
After 5 years, there’s 15*12 = 180 instalments left, the PV of mortgage repayments will be:
3635.76 * (1 – 1.003333^-180) / 0.003333 = 491,495.3
You are left with: 1,400,000 - 491,495.3 = 908,504.70
