Question

a) A loan of £100,000 is repayable by equal quarterly payments for 4 years. The effective rate of interest is 7% pa. REQUIRED

I. Find the equal quarterly payment amount.
II. Draw the amortization schedule for the loan repayment.
III. What is the interest portion paid on the 6th payment? IV. What is the total interest paid after the 12th payment?

b) Give a brief description of the following types of financial investments and list the risks and benefits associated to each type of financial investments
I. Cash
II. Fixed Income Securities
III. Equity
IV. Property

Answer 1

Answer (a)(i)

Calculation of equal quarterly payment amount

Informations given in the question are as follows:

Loan amount (P) = £ 1,00,000

Loan period = 4 Years

Interest rate (R) = 7% per annum, therefore [7% /12]*3 = 1.75 % per quarter

No. of instalment (n) = 16

Amount of quarterly payment = ?

EQI (Equal quarterly instalment) can be calculated by using the formula given below-

EQI = [P X r X (1+r)^n]/[(1+r)^n - 1]

Here:

EQI = Equal quarterly instalment

P = Principal amount (Amount borrowed)

r = R/100

R = Rate of interest per quarter

n = No. of payments

Now, by putting the informations given in the question in formula we can calculate the EQI.

Therefore

EQI = [£ 1,00,000 X 0.0175 X (1 + 0.0175)^16]/ [ (1+ 0.0175)^16 -1]

EQI = £ 7219.96 (£ 7220 approx)

Answer (a)(ii)

Amortization Schedule for loan repayment

SI	Opening Loan amount	Interest amount @1.75 %	Principal Amount	EQI	Balance
1st	£1,00,000	£ 1,750	£ 5,470	£ 7,220	£ 94,530
2nd	£ 94,530	£ 1,650	£ 5,570	£ 7,220	£ 88,960
3rd	£ 88,960	£ 1,557	£ 5,663	£ 7,220	£ 83,297
4th	£ 83,297	£ 1,458	£ 5,762	£ 7,220	£ 77,535
5th	£ 77,535	£ 1,357	£ 5,863	£ 7,220	£ 71,672
6th	£ 71,672	£ 1,254	£ 5,966	£ 7,220	£ 65,706
7th	£ 65,706	£ 1,150	£ 6,070	£ 7,220	£ 59,636
8th	£ 59,636	£ 1,044	£6,176	£ 7,220	£ 53,460
9th	£ 53,460	£ 939	£6,281	£ 7,220	£47,179
10th	£47,179	£ 826	£ 6,394	£ 7,220	£ 40,785
11th	£ 40,785	£ 714	£ 6,506	£ 7,220	£ 34,279
12th	£ 34,279	£ 600	£ 6,620	£ 7,220	£ 27,659
13th	£ 27,659	£ 484	£ 6,736	£ 7,220	£ 20,923
14th	£ 20,923	£ 366	£ 6,854	£ 7,220	£ 14,069
15th	£ 14,069	£ 246	£ 6,974	£ 7,220	£ 7,095
16th	£ 7,095	£ 124	£ 7,096	£ 7,220	0

Answer (a)(iii)

Interest portion paid on the 6th payment = £ 1,254. (Refer above table)

Answer (a)(iv)

Total interest paid after the 12th payment = ( £ 484 + £ 366 + £ 246 + £ 124) = £ 1,220.(Refer above table)

Answer (b)

(1) Cash Investment: Cash investment is a short term obligation, that provides return in the form of interest payment.

Risk:

(1) Low return compare to other investments.

Benefit:

(1) High liquid investment

(2) Low risk involved

(2) Fixed income securities: Fixed investment securities are debt instruments that pay a fixed amount of interest in the form of coupon payment to investors.Bonds are the most common form of fixed income securities.

Risk:

(1) Interest Rate Risk

(2) Credit Risk

Benefits:

(1) Stability of returns

(2) Safe investment

(3) Priority during liquidation

(3) Equity Investment: Equity investment refers to buying shares in a particular company and, thereafter,holding it in order to gain ownership interest that can be sold later to generate reasonable returns depending on its investment objectives.

Risk:

(1) Dividend uncertainity

(2) High risk

(3) Limited control

(4) Price fluctuation risk

Benefits:

(1) Dividend entitlement

(2) Capital gain entitlement

(3) Claim over income and assets.

(4) Property: Investment in property is with the intention of earning a return on investment either through rental income, the future resale of the property or both.

Risk:

(1) You could get bad tenants.

(2) Interest rate could rise

Benefits:

(1) Rental Income

(2) You can leverage your investment.