Explain how an investor can set a stream of future payments from an investment equal to its present value. Give two reasons why an investor might be interested in the present value.
Project description
• a.Explain how an investor can set a stream of future payments from an investment equal to its present value. Give two reasons why an investor might be interested in the present value. (10 marks)
• b.An investor is faced with three possible choices, shown in Table 1. Using the Investment Tool (Present Value & Discount Rate segment), calculate the rate of return from each investment product. Explain the figures you have entered in the Investment Tool, and explain which is the most attractive investment opportunity. (20 marks)
• c.Explain how your choice of investment product might change if the current price of government bonds in Table 1 increased to £140 for each £100 nominal of the bond, while the other investment products remained unchanged. (10 marks)
• d.For private investors it is sometimes suggested that government bonds are close to being a risk-free asset, but this is not always the case. Explain any two risks associated with holding government bonds. (10 marks)
Table 1: Three investment products to choose between
Product 1 Corporate bonds with a coupon of 7 per cent purchased at a current price of £120 for each £100 nominal to be held until redemption after four years. The coupon is paid each year in one instalment.
Product 2 Shares in Sumsang, purchased at a current price of £8 per share, paying four equal dividends a year of 25p each. The shares will be held for six years, after which they are expected to be sold at a reduced price of £5 per share.
Product 3 Government bonds with a coupon of 11 per cent purchased at a current price of £105 for each £100 nominal redeemed after 10 years. The coupon is paid each year in two half-yearly instalments.