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Sir, kudos for the great job that you’re doing!! 🙂
I have a couple of qns related to this qn.
1) forward rate: 142 x (1 +(0.085+0.0025)/3) / (1 + (0.022-0.003)/3)
Why are we dividing it the int rates by 3 separately? If we are computing the forex rate for the next yr using int rate parity, we simply multiply the spot with (1+int rate in foreign)/(1 + int rate at home). So for 4 months, shouldn’t we just multiply the whole thing with 4/12?2) option: once the foreign currency has been converted to the home currency, the kit states “its assumed that the funds for this need to be borrowed, so this is multiplied by the borrowing rate for the total cost”. Why are we doing this? Is this necessary?
1 If you are forecasting for 4 months that you should use the 4 month interest in the formula. 4 months interest is 4/12 (or 1/3) of the annual rate.
2 The option premium is payable immediately, whereas we would otherwise only have a cash flow in 4 months time. So we should account for the interest paid (or lost) on the premium if we want to be able to compare the end result with any other method. It is a fairly minor point, but still.
Yes sir, I got that. But shouldn’t wr be doing it this way? 142 x (1 +.085 + 0.0025)/(2 +.022 – 0.003) x 1/3? Why are we diving (0.085 +.0025) by 3 and adding it to 1, and similarly dividing (0.033-0.003) by 3 and adding ut to one?
Why do you want to do it differently from the formula???
Using the formula we multiply by (1 + Zuhait interest) and divide by (1 + French interest)
The Zuhait interest is 8.5%+0.25% = 8.75% for a year, and therefore 8.75/3 for 4 months.
The French interest is 2.2%-0.30% = 1.90% for a year, and therefore 1.90/3 for 4 months.The answer that you would get doing it your way would be such a ridiculous forward rate that it would obviously be wrong.
For the calculation of the option… why we must calculate cost of borrowing as 1+0,037/3. We need the money now but we will return them later so I would think that the only additional cost for borrowing money to pay the premium will be the interest of 0,037/3 not the whole borrowing.
The premium itself is always a cost (which we will never get back).
However, because it is payable immediately (whereas the other flows are not payable until later), we really need to increase the cost by the cost of the interest on it over that period.Sir,
In calculating the borrowing cost, I thought the interest rate should be 2.2%-0.30% = 1.90% + 1.5% = (1+ 034/3). How did they arrived at (1+037/3)?
The paragraph in the question that refers to the premium cost says that they can borrow money at base rate plus 150 basis points (i.e. 1.5%).
Since base rate is 2.2%, it means the money borrowed for the premium is at 2.2 + 1.5 = 3.7% per year. They are borrowing for 4 months, so the rates is 3.7% / 4Thanks,please my question regarding this is that why is the basis point 0.0025 rather than 0.25 (25/100).please kindly clarify before I take the wrong thing into the exam?
25 basis points is 0.25%
Just as 1% is the same as 0.01, so too 0.25% is the same as 0.0025
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Dear Sir,
Thanks for all this invaluable help you’re providing!
The day of the exam is closing in and i guess you’ll be receiving daily notifications for P4?!
I have a few questions on Lignum arising from the way BPP solved the amended (added) part b(i). It used the cost of capital and inflation to find the ‘real’ rate and used that to discount the cash flows. Why not use the cost of capital? How is that different from all the other questions where cost of capital is used to discount/annuity factor (calculate)?. Is it because BPP assumed that the cash flows were inflated?
Also, in finding the NPV of the development costs (for finding Pa), it discounted EUR2,5m individually. I solved by multiplying with AF (12%, n=3) and i did not get the same result. Is it because y=0 is actually y=1 when using AF? How can we use AF to find PV of the 2,5 cash flow instead of discounting each cash flow individually? (i tried AF with n=3, 12% and discounting DF12% n=1 but i still couldn’t get the result)
Thank you very much in advance!
The question says that the prices will inflate at 4% per annum. So you can either discount the nominal (actual) cash flows (i.e. with inflation) at the cost of capital, or alternatively you can discount the real cash flows (i.e. without inflation) at the real cost of capital. Both ways will give the same answer, but the second way is faster because it is for so many years.
With regard to the 2.5M, the annuity factor always discounts flows starting in 1 years time. Here the first flow is immediate and so the PV of it is 2.5M. There is then 2.5M a year at times 1 and 2, so you could use the 2 year annuity factor to discount these (and then add the PV to the 2.5M of the immediate flow).
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Thank you very much for the prompt reply!
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