QUANTITATIVE PROBLEMS

Chapter 1:
1. Use the following table of exchange rates (from February 1, 2014 to February 28, 2014) to answer
the questions below.

DATE USD per EUR DATE USD per EUR

2/1 1.348781 2/16 1.369300

2/2 1.328781 2/17 1.370679

2/3 1.352399 2/18 1.375730

2/4 1.350628 2/19 1.376089

2/5 1.351799 2/20 1.368862

2/6 1.360180 2/21 1.372465

2/7 1.361194 2/22 1.373730

2/8 1.363577 2/23 1.373741

2/9 1.363577 2/24 1.374172

2/10 1.364353 2/25 1.374726

2/11 1.365278 2/26 1.367002

2/12 1.359235 2/27 1.371264

2/13 1.366882 2/28 1.380712

2/14 1.369081    
2/15 1.369300    

a) On which date would it have been the best to exchange $300 into euros?

2/2/14 1.328781 EUR 225.77

b) On which date would it have been the worst?

2/28/14 1.380712 EUR 217.28

c) What is the difference, in euros, between the best and worst exchange date?

EUR 225.77 – EUR 217.28 = EUR 8.49

QUANTITATIVE PROBLEMS (from Ch. 3 in Mishkin and Eakins, 2018)
1. Calculate the present value of a $1,000 zero-coupon bond with six years to maturity if the yield to
maturity is 7%.
FV 1,000
   $666.34
Solution: Bond price present value (1  YTM) M (1  0.07) 6

6. Calculate the yield to maturity on the bond that has a price of $1,000 and pays $50 dividend for
the life of the bond. What will happen if the dividend is $25 instead of $50?

Solution: Since the bond pays dividends forever, I = C/P, where I is the yield to maturity, C is the
yearly payment of $50 in this case, and P is the price of a bond, which is $1,000 in this case; I =
50/1000 = 0.05 or 5%;
If the payment is $25, I = 25/1000 = 0.025 or 2.5%.

7. Suppose you bought land that costs $500,000 today. You will need to continue to pay tax on the
land, and the rate is 3% of your purchase. Calculate the PV of your payment, using a 10% discount
rate. Assume that there are no changes in the land’s price and tax rate.

Solution: Yearly payment will be 500,000  3% = 15,000.

Present value of future payments is 15,000/0.10 = 150,000 (a perpetuity).

8. Suppose that you want to take out a loan at a bank that wants to charge you an annual real
interest rate equal to 5%. Assuming that the expected rate of inflation during the life of the loan is
2%, what will be the nominal interest rate that the bank will charge you? If the real inflation was 3%
instead of the expected 2%, what was the actual real interest rate on the loan?

Solution: Since the bank wants to charge an annual real interest rate of 5%, and the expected
rate of inflation is 2%, according to the Fisher formula, the nominal interest rate will be 5% + 2%
= 7%; If the real inflation was 3%, and the nominal interest rate on the loans was 7%, using the
same formula, the real interest rate is 7% - 3% = 4%. Therefore, the bank received 4% rather
than 5% on your loan.

9. Anna bought a bond with a par value of $10,000 and a coupon rate of 8% at par. After a year, she
was able to sell her bond for $11,000. Calculate the rate of return on Anna’s investment. What is the
current yield and capital gain on her investment?

Solution: Return on investment = (coupon payment + price in the following year - the current
price)/current price;

Return on investment = (800 + 11,000 – 10,000)/10,000 = 0.18 or 18%;

The current yield will be 800/10,000 = which is 8%, and the capital gain will be (11,000
-10,000)/10,000 = 0.1 or 10%.
 10. Suppose that you have a bond with a face value of $1,000 and a coupon rate of 8% for one year
and that you buy another one after one year. What will be your gain if the interest rate increases up
to 10%? How will your answer change if the interest rate falls to 6%? What conclusion can you draw
from these cases?

Solution: After one year, you will have 1,000 + (1,000  8%) = 1,080.
If the interest rates rise up to 10%, for the $1,080 that you have invested, you will get back
$1,080 + $108 = $1,188. The total interest earned is (1,188 – 1,000)/1,000 = 0.1880 or 18.80%.
Compute the annual return: 1,000 x (1 + i)2 = 1,188 which gives us i = 8,99%
If the interest rate falls to 6%, for the $1,080 that you have invested, you will get back 1,080 +
64.80 = 1,144.80; the total interest earned is (1,144.80 - 1,000)/1,000 = 0.1448 or 14.48%.
Compute the annual return: 1,000  (1 + i)2 = 1,144.80; i = 6.99%.
From the above cases, you can draw the conclusion that when the holding period is greater
than the term to maturity, return is uncertain. This is, therefore, about reinvestment risk. You
may be better off if interest rates increase and vice versa.

QUANTITATIVE PROBLEMS Ch. 5

1. Use the U.S. interests provided by the U.S. Department of the Treasury or Federal Reserve to
construct a yield curve in Excel for Monday, September 28th 2020:
https://www.federalreserve.gov/releases/h15/
OR
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?
data=yield
In order to construct a yield curve of U.S. Treasuries, yields of several maturities (for example 1
month, 2 month, 3 month, 6 month, 1 year, 2 year, 3 year….30 year) must be plotted for the
given date.

QUANTITATIVE QUESTIONS (from Ch. 11 in Mishkin and Eakins, 2018)

1. Calculate the annualized discount rate and annualized investment rate on the purchase of 91-day
T-bill, if the face value is $3,000 and purchase price is $2,900.

Solution:

Annualized discount rate = [(3,000 - 2,900)/3,000]  (360/91) = 0.1318% or 13.18%

Annualized investment rate = [(3,000 - 2,900)/2,900]  (365/91) = 0.1379% or 13.79%

3. Suppose you want to earn an annualized discount rate of 2.5%. What would be the most you
would pay for a 182-day Treasury bill that pays $10,000 at maturity?
 Solution: 0.025 = (10,000 − X)/10,000 × 360/182
0.025 = (3,600,000 – 360X)/1,820,000
45,500 = 3,600,000 – 360X
360x = 3,600,000 − 45,500
X = 3,554,500/360 = $9,873.61

5. The price of a 145-day commercial paper is $4,525. If the annualized investment rate is 5.25%,
what will the commercial paper pay at the day of maturity?

Solution: Let X be what the paper will pay at the day of maturity
(X – 4,525)/4,525 × 365/145 = 0.0525

(X – 4,525)/4,525 × 2.5172 = 0.0525

(X – 4,525)/4,525 = 0.02086

X – 4,525 = 94.38

X = 4,619.38

FORMULAS:

F−P 360
i discount = ×
F n

F−P 365
i investment = ×
P n

QUANTITATIVE QUESTIONS (from Ch. 12 in Mishkin and Eakins, 2018)

1. You are considering buying a bond that matures in 10 years from today. The par value of the bond
is $10,000 and the coupon rate is 7%. If the current market interest rates are 5%, what is the bond
price today if the coupon is paid annually?

1 1  Principal payment
P  Coupon payment    n 

Solution:  r r (1  r )  (1  r ) n

 1 1  10,000
P  700    10 

 0.05 0.05(1  0.05)  (1  0.05)
10

P  700   20  12.27826507   6,139.132535

P  5, 405.214451  6,139.132535  $11,544.35
2. What is the current yield to maturity on the zero coupon bond that has a face amount (or par
value) of $1,000 and the current market price for the bond is $ $850? The bond matures in 4 years.
(1/years to maturity )
 Face Value 
Yield to Maturity:   –1;
 Current price 
(1/4 )
 1000 
   1  0.0414664 or 4.1466%
Solution:  850 

6. An investor is considering two bonds. One is a corporate bond yielding 12%, and is currently selling
at par. The marginal tax rate is 28%. The other is a municipal bond with a coupon rate of 9.50%.
Which should the investor choose?

Solution: Net return after tax for corporate bond = 0.12 × (1 – 0.28) = 0.0864 ≈ 8.64%

Compared against the municipal bond coupon of 9.50%, it is a smaller percentage.

Since 8.64% < 9.50%, the investor should choose the municipal bond over the corporate bond.

12. A one-year premium bond with a face value of $10,000 has been purchased for $11,150. What is
the yield to maturity?

Solution: 11,150 = 10,000/(1 + YTM); YTM = –10.31% or a negative yield;

Yield on discount basis: (10,000 - 11,150)/10,000 × (360/365) = –11.34%

QUANTITATIVE QUESTIONS (from Ch. 13 in Mishkin and Eakins, 2018)

1. Suppose you want to buy a stock, which has an expected dividend of $1 next year and an expected
stock price of $55 next year. How much are you willing to pay for this stock today, if your required
rate for investment is 14%?

Solution: To determine the current price of stock, use One-Period valuation method:

Since the required rate of return is 14%, discount both the stock value and expected dividend for
one year:

D1
P 0=
P1
( 1+ k ¿¿ e)+ ¿
(1+ k ¿¿ e)¿
P0 = 1/(1 + 0.14) + 55/(1 + 0.14) = 1/1.14 + 55/1.14 = 49.12; So the current price is $49.12, which is
the maximum you can pay for the offered stock today.

2. If I buy a stock today at £20.00 and sell it next year for £23.50, what is my rate of return? If I
received a dividend of £0.17 during that time, what is my rate of return?
 P t+1 −P t 23.50−20
Rate of Return= = =0.175=17.5 %
Pt 20
D+ P t+1 −Pt 0.17+23.50−20
Rate of Return= = =0.1835=18.35%
Pt 20
3. The shares of Misheak, Inc. are expected to generate the following possible returns over the next
12 months:

Return Probability

-5% 0.10
5% 0.25
10% 0.30
15% 0.25
25% 0.10

If the stock is currently trading at $25/share, what is the expected price in one year? Assume that the
stock pays no dividends.

Solution: The expected return over the next 12 months is calculated as:
N
X́ =∑ pi X i
i=1

(-0.05  0.10) + (0.05  0.25) + (0.10  0.30) + (0.15  0.25) + (0.25  0.10) = 0.10

This suggests that the expected price is $25  (1.10) = $27.50

7. Find the current market price of company’s share, assuming D0 = $1.5, dividend growth rate 5%
and required rate 12%. Use the Gordon Model for share value evaluation.

Solution: Using the Gordon growth model, we can easily find the following:

D 0 ×(1+ g)
P 0=
( k ¿¿ e−g)¿
P0 = 1.5  (1 + 0.05)/(0.12 – 0.05) = 1.5  1.05/0.07 = $22.50

15. The average industry P/E ratio for IT companies is 27. What is the price of an ABC share if the
their expected earnings is $1.15 per share?

Solution: Using the Price Earnings formula, calculate the current price:

P
Price= × Earnings
E
P = 27  1.15 = $31.05
Formulas:

D+ Pt +1−Pt
RoR=
Pt
D1
P 0=
P1
( 1+ k ¿¿ e)+ ¿
(1+ k ¿¿ e)¿

D 0 ×(1+ g)
P 0=
( k ¿¿ e−g)¿

P
Price= × Earnings
E

N
X́ =∑ pi X i
i=1

QUANTITATIVE QUESTIONS (from Ch. 15 in Mishkin and Eakins, 2018)

1. Suppose you want to buy a German car, which costs €55,000. What will be price of this car in the
United States if the exchange rate is €0.90 per U.S. dollar? What will happen to the price if the
exchange rate increases to €0.95 per U.S. dollar?

Solution: If 1 US dollar = €0.90, then €1 = 1/0.90 US dollar = 1.11 US dollar. The cost of the car
will be 55,000 × 1.11 = $61,050;

If 1 US dollar = €0.95, then €1 = 1/0.95 = 1.05 US dollar. So, the cost of the car becomes 55,000 ×
1.05 = $57,750. Since the US dollar appreciated in relation to the euro, the cost of the car in US
dollars becomes slightly lesser.

2. An investor in England purchased a 91-day T-bill for $987.65. At that time, the exchange rate was
$1.75 per pound. At maturity, the exchange rate was $1.83 per pound. What was the investor’s
holding period return in pounds?

Solution: The bond cost $987.65/$1.75 = £564.37.

At maturity, the $1,000 is worth $1,000/$1.83 = £546.45.

The holding period return is (546.45 ‒ 564.37)/564.37 = ‒0.0317.

9. The Argentinean peso trades at 0.067 U.S. dollars per Argentine peso. How many Argentinean
pesos would you tip a taxi driver if you give her a $5 bill?

Solution: Each US dollar is worth 1/0.067 = 14.92 Argentine pesos. Therefore, a $5 bill is equivalent
to almost 75 Pesos.