An Assignment

On

The Determinant of interest rate

Course Title: Financial Markets and Institution

Course No: FIN-403

Submitted To:

S.M. Zahidur Rahman

Assistant Professor

Submitted By:

Sharmin Sultana-070318

3rd year, 2 nd term

Business Administration Discipline

Khulna University, Khulna

Date of Submission: 15th November,2009

 Answer to the question no-3

Here, Market interest rate= 12%, project year=10 year, Cash outflow= 15, 00,000
Cash inflow= $500,000* PVIFA (12%, 10 YEAR)
= $500,000*5.650
=$28, 25,000

We know that NPV= PV of Cash inflows- PV of Cash outflows

= $28, 50,000-$15, 00,000
= $13, 50,000

We know that if NPV of any project is more than zero, it should be accepted because
it shows the profitability of the project. So, in this case the project should be accepted.

Answer to the question no-4

Here, coupon interest rate= 9%, Market interest rate=11%, Face value of the bond=
$1000, maturity=10 years

Market price of the bond = Interest* PVIFA (11%, 10 year) + M*PVIF (11%, 10
year)
= 90* 5.889+ 1,000*.352
= 882.01

If the bond price declines to 7%, the market price of the bond will be,
= 70* 5.889+1000*.352
= 764.23

As interest rate of the bond declines, the present value of the total interest will decline
also and consequently the market price of the bond will be reduced.
 Answer to the Question no- 5

a) The first statement, we can determine it under the theory of Liquidity Preference
Theory because it tells that central bank controls the interest rate by manipulating
the supply of money. So in this statement it is mentioned that Federal Reserve
through credit policy controls the interest rate , here we find some similarity with
Liquidity Preference Theory.
b) The second statement shows the balance of bond and stock market effects that
means the balance between supply of money and the demand for money. we find
some resemble with Rational Expectation Theory of Interest, it indicates that
money and Capital market are highly efficient in the use of new information
which affect the security price and interest rates.

Answer to the question no- 6

Total demand for funds Total volumes of savings Alternative market

expected interest rates
$170 $80 5%
155 96 6
142 103 7
135 135 8
128 178 9
111 207 10
92 249 11
86 285 12

According to the classical interest theory we know that the equilibrium rate of interest
is determined at the point where the quantity of savings supplied to the market is
exactly equal to the quantity of fund s demanded for investment. We can show it
graphically:

If the volume of savings exceeds the demand for investment capital, creating an
excess level of savings at that time the interest rate will be temporarily above
equilibrium.
Again if investment demand exceeds the quantity of savings the market interest rate
lies below equilibrium.
 Answer to the question no-7:

We know that according to the liquidiuty preference theory , the amount of demand =
the amount of supply.
Here, MD=30-2i
And , MS=3+7i
So, 30-2i=3+7i
Or, 7i+2i=30-3
Or, 9i=27
Or, i=3
Equilibrium interest rate is the point where demand and supply will be equal, if u put
the interest rate we got , the demand for money will be= 30-2*3=24 and supply for
money will be=3+7*3=24
So, we can say that the equilibrium interest rate according to theLiquidity Preference
Theory is =3

Answer to the question no-8:

To determine the IRR and NPV, we need to calculate net present value of the cash
flows.

Present Value of cash flows (project-A) = $3310*PVIFA (12%, 5 year)

= $3310*3.605
=$11932.55

Present Value cash inflows (project-B) = $6525*PVIFA (12%, 5 year)

= $6525*3.605
= 23522.625

NPV of project-A= 11932.55- 9870= 2062.55

NPV of project-B=23522.625-17850=5672.625

In the perspective of NPV, both project can be taken as they are more than zero or
positive.

We know that IRR the rate at which the NPV is zero. So to calculate IRR we have to
determine at which point NPV is zero.

In case of project-A:
If IRR is 20%, NPV will be=9900.21-9870= 30.21

Again, if IRR is 21%, NPV will be = 9685-9870= (-184.99)

So, IRR will be between 20% and 21%

Specifically, IRR= 20%+ 30.21-0/ 30.21-(-184.99)*1%= 20.14%

Again in case of project-B:

If the IRR is 24%, NPV will be =63.63

And if it is 25%, NPV will be = (-304.275)

So, IRR specifically= 24%+63.63-0/63.63-(-304.275)*1%

=24.17%

IRR should be more than cost of capital. Here, cost of capital is 12%, so both the
project is acceptable as they are independent projects.