Question

There is a financial product A which is guaranteed by government generates 12% annual return. It has no default risk and only exposure to liquidity risk and maturity risk. Assume there is another same term product that provides 2% maturity premium and 1.5% default risk premium. If the expected inflation rate is 3% next year, the real return of one-year treasury note is 2.5%. The implicit liquidity premium compensated by product A is equal to: A financial product that promises to pay 6.5%, monthly compounding. If you desire an amount of 386,000 to buy a brand new BMW X3 when you are 35 years old, how much money you have to save each month to fulfill your wish at the day you graduate from school when you are 22 years old?

Answer 1

1	as we know interest rate
	R = r* + IP + DRP + MRP + LP
	Here for govt security DRP is 0
	so,
	12% = 2.5% + 3% + 0% + 2% + LP
	LP = 12% - 7.5%
	LP = 4.5%
	We can verify it since for normal security
	R = 2.5%+3.%+1.5%+2%+4.5% = 13.5%
	its more than govt security by 1.5% that is just because DRP is 1.5% in normal security
	and 0 in govt security
2	Since you start saving when you were 22 yrs old till you got 35th yr age
	Its 13 yrs saving time or 156 months for which you have to save a target amount
	So:
	Set
	FV	386000
	NPER(N)	156	(13 x 12)
	Rate(I/Y)	0.0054167	(6.5%/12)
	PMT	($1,580.76)		Press CPT+PMT in BA-II to get the results
		=PMT(6.5%/12,156,,386000)
	So you have to save $1,580.76 per month to have $386000 at 35th birthday