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Hi,
I’m don’t understand why an annuity factor is calculated (1-0.0350/0.0350) to determine the fixed repayment of interest and capital for the new bond?
Thanks,
If money is borrowed, then the PV of the interest payments and repayment of principal when discounted at the interest rate will always be equal to the amount borrowed.
This is the case however the money is repaid.
If they pay an equal amount each year to cover the repayment of both interest and principal, then the PV of the these repayments will be the amount each year x the annuity factor.
So the amount of the annual repayment will be the amount borrowed divided by the annuity factor.
In this question, the amount borrowed is $100. The interest is 3.57% and it is for 5 years.
So we divide $100 by the 5 year annuity factor at 3.57% to get the annual repayment.Since the tables do not give the annuity factor at 3.57%, you have to calculate it yourself using the formula that is given in the exam at the top of the annuity tables.
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