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Question 1 (a)
In the Return phase:
1. How to calculate the “terminal value of property”?
2. How to get the figures for “project operating cash flow (nominal)”?
Question 5 (a) (i)
The model answer given,
1. Step (4)
Spot price – futures price = 94.00 – 93.88
Is the spot price = the middle row in the options table of the question (exercise price of 94000)?
Actually, what is the purpose of this step (4) computing 12 basis points or ticks? What does it mean by “… maturity is four ticks given the contracts will have one month to run”?
2. Step (5)
Why the close out will need to deduct 0.04? How can I get the 0.04?
3. Step (6)
How to get the cost of loan in spot market of 750,000 and 550,000?
The annual equivalent of 6.58%, if I use it to recover the total loan amount by 658,000/0.0658, I get 10,000,000, but I do not see it from the question?
Q1:
The construction cost is 6.2M. Hotel values will increase by 8% p.a. in real terms. So inflate for 5 years at 8% and 2.5% to get actual terminal value.
This needs reducing by the cost for repairs and renewals, which is 1.2M at current prices, so inflate this for 6 years at 2.5% p.a.The real operating flow at time 2 is 52000, so to get the nominal flow inflate it for 2 years at 2.5% p.a.
Similarly the real op flow at time 3 is 490,000, so to get the nominal flow inflate it for 3 years at 2.5% p.a.And so on…. 🙂
Q5:
1. The spot price is the current LIBOR quoted as a futures price. 6% is equivalent to 100 – 6 = 94
We need the difference between spot and futures price (the basis) in order to estimate what the difference will be at the time the loan starts. We assume that the basis falls linearly over the life of the future. (You don’t need to do it in ticks even though you are effectively doing the same thing).
(It might be worthwhile you watching my lecture on interest rate risk)
2 The 0.04 (or 4 ticks) is 1/3 time the current difference of 0.12 (or 12 ticks). Again it is because we assume that the basis is falling linearly to zero over the life of the future.
3 If LIBOR is 7% then they will be 7.5% (libor + 50 points).
The borrowing is for 4 months, and so the interest is 30M x 0.075 x 4/12 = 750,000They end up paying a net 658,000 on a loan of 30M
This is interest of 658000/30M over 4 months.
So the annual equivalent is 658000/30M x 12/4 = 6.58%
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