Using examples, explain the differences between the primary and secondary markets for securities.
Discuss systemic risk and any effects that it might have on investors. Give an example.
Joanna is interested in purchasing a government bond parcel. She asks you to explain how it is possible that an investor can make or lose money on fixed interest investments. As part of your explanation, calculate the purchase price of a 10-year government bond parcel with two full years remaining in its term. The bond's yield rate is 8.95% p.a., paid as a half-yearly coupon, and assume that the prevailing market interest rate is 7.50% p.a. Use a parcel price of $100.
Yanni asks you to explain why different discounted cash flow (DCF) calculations use different discounting rates. Use the information provided below to frame your explanation. Yanni and Joanna's current investment property was purchased six months ago (assume this was in the current financial year) for $418,000 in an area that they believe has high growth prospects. They have an interest-only loan of $280,000 attached to this property. The expected sale price in three years is $575,000. Cash flows from the property are:In year 1:
Rent income $33,000
Cash expenses $12,500
- In year 2, rent income is expected to increase by 2% compared to year 1 and cash expenses are expected to increase by 1.5% compared to year 1.
- In year 3, rent income is expected to increase by 2.5% compared to year 2 and cash expenses by 2.0% compared to year 2.
The appropriate discount rate is 8.75%, being the risk-free rate plus a premium. The discount rate also recognises the interest rate for the property loan of 7.75%.
In your response, you should address the following points:
a) Explain why DCF is used to evaluate investments and what impact increasing the discount rate will have on the results of a DCF valuation.
b) Calculate to the nearest dollar the present value (PV) and net present value (NPV) of the couple's investment property.
c) Calculate the internal rate of return (IRR) of this investment to one decimal place.
d) Explain whether this investment is good value if comparative properties are returning 15.25% per annum.