Question

Investment is the purchase or creation of assets to to make gains in the future. Typically investment involves using financial resources to purchase a machine or building or securities or other assets, which will then yield returns to an organization or individual over a period of time.

Last year, Gary graduated with a Foundation in Arts from Quest International University Ipoh and received RM5,000 from his father as a graduation gift. Gary, now in his first year of a degree program, recently heard from a friend who earns a profit from investing in the bond market during this pandemic time.

Gary does not know much about investing or how people actually “make money by investing”. He asked you to help him in making a wise investment plan.

1. Before investing any money, explain to Gary about the risk involved.   
2. Calculate the expected rate of return Gary would receive if he buys bonds in Ace bond. Ace bond is a 15-year, RM1,000 par value bond that pays 5.5 percent interest annually. The market price of the bond is RM1,085.       
3. Determine the value of the bond given Gary’s required rate of return is 7 percent.
4. Advise Gary if he should buy the bond. Justify your answer.
5. Gary’s father, Mr. Xi is valuing an investment that will pay him RM12,000 the first year, RM14,000 the second year, RM17,000 the third year, RM19,000 the fourth year, RM23,000 the fifth year, and RM29,000 the sixth year (all payments are at the end of each year). Determine the value of the investment to Mr. Xi now if the appropriate annual discount rate is 11%.    

Need help for a, b, c, d and e

Answer 1

a. Some of the risks involved in inesting in the bonds are as follows:

1. Interest Rate Risk: Rising interest rates are a key risk for bond investors. Generally, rising interest rates will result in falling bond prices, reflecting the ability of investors to obtain an attractive rate of interest on their money elsewhere.
2. Credit Risk: This is the risk that an issuer will be unable to make interest or principal payments when they are due, and therefore default.
3. Liquidity Risk: This is the risk that investors may have difficulty finding a buyer when they want to sell and may be forced to sell at a significant discount to market value.
4. Reinvestment Risk: When interest rates are declining, investors may have to reinvest their coupon income and their principal at maturity at lower prevailing rates.
5. Inflation Risk: Inflation reduces the purchasing power of a bond’s future coupons and principal

b. The Expected Rate of Return is 5% as computed below:

Formula Used in excel "=IRR(range of cells)"

Year	Cash Flow
0	-1085
1	55
2	55
3	55
4	55
5	55
6	55
7	55
8	55
9	55
10	55
11	55
12	55
13	55
14	55
15	1055

c. The Present Value of RM1,000 that Gary would receive after 15 years @7% comes to RM362 (1000*.362)

The Present Value of RM55 that Gary would receive each year for 15 years discounted @7% comes to RM500.94 (55*9.10791)

Hence, Value of the Bond for Gary = RM862.94

d. Since, value of the bond for Gary is RM862.94 and actual market value of the bond is RM1,085, it is not advisable for Gary to invest in this bond.  

e. The value of the investment to Mr. Xi @ 11% annual discount rates comes to RM76,282 as computed below:

Year	Cash Flow	PV @ 11%	PV
1	12000	0.901	10812
2	14000	0.812	11368
3	17000	0.731	12427
4	19000	0.659	12521
5	23000	0.593	13639
6	29000	0.535	15515
			76282