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Sir, In GNT CO (PILOT 12) , how they have calculated the Gross Redemption Yield? this question is available in BPP exam kit.
Gross Redemption Yield
Try 5%
60 × 1.05–1 + 60 × 1.05–2 + 60 × 1.05–3 + 60 × 1.05–4 + 1,060 × 1.05–5 =
60 × 4.3295 + 1,000 × 0.7835 = 1,043.27
Try 4%
60 × 4.4518 + 1,000 × 0.8219 = 1,089.01
i = 4 + [(1,089.01 – 1,079.68)/(1,089.01 – 1,043.27)] = 4.2%I didn’t get how they have calculated the IRR!(i = 4 + [(1,089.01 – 1,079.68)/(1,089.01 – 1,043.27)] = 4.2%)
But it is the normal calculation of IRR even though the examiner showed the workings in a different way. Presumably you arrived at 4.2% as well before you checked the answer, so how you show the workings is irrelevant.
At 4% the NPV = 1,089.01 – 1,079.68 = 9.33
At 5% the NPV = 1,043.27 – 1,079.68 = (36.41)The difference in the NPV’s is 45.74
Therefore the IRR = 4% + ((9.33/45.74 x 1%) = 4.2%
Good day sir, for GNT question – part b i have some confusions about the concept. Usually it is said that if interest rate increase then share price decrease as we assume it as linear relationship. The interest rate they mentioned is the market interest rate or YTM which we used to discount the cash flows using IRR method to get NPV=0?
My second doubt is that if the interest rate increase, bond price reduces right, how about the duration sir, it will also reduce?Firstly, if the investors required rate of return increases then the market value of shares (or of bonds) decreases because the market prices are the present value of the future receipts discounted at the required return (as I explain in my lectures). Discounting at a higher rate of interest automatically always results in a lower present value.
As far as assuming linearity is concerned, the relationship is not linear. We assume linearity when calculating the IRR using 2 guesses, and as a result the answer is only an approximation (as explained in my free Paper FM lectures). However given that you have an IRR function available in the spreadsheet provided in the exam, this is no longer relevant because the answer resulting using the function is the exact IRR and not an approximation.
With regard to the duration – this is all explained in my free lectures on Chapter 11 of our free lecture notes.
Noted sir, i will have a look on the free lectures to learn more about it.
Thank you so much sir
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