1. Compounding is not restricted to money values - it can be applied to growth rates in many business and economic values. In business jargon, it is often called the compound annual growth rate or CAGR. This is the same as a compounding interest rate.
The International Air Transport Association predicts that, in 2017, 487.9 million passengers will fly domestic routes in China, the second largest number in the world behind the U.S. This prediction represents a 10.2% CAGR on 2012 passenger numbers.
(International Air Transport Association 2013, 'Airlines expect 31% rise in passenger demand by 2017', 10 December, available at www.iata.org/pressroom/pr/pages/2013-12-10-01.aspx, accessed 20 February 2015.)
i) If this growth rate can be expected to continue beyond 2017, what is your prediction for the number of passengers flying domestic routes in China in 2020? (0.5 marks)
ii) What is the CAGR for a Chinese domestic airline that carried 20 million passengers in 2012 and 28 million passengers in 2014? If this CAGR is expected to continue, what market share do you predict for the airline in 2020? (1 mark)
2. On 1 July 2014 you borrow $350,000 to buy an investment property at Coolangatta. The rate on the loan is fixed for the first 5 years at 5.49% and the loan requires monthly payments, due on the last day of the month, over a 30 year term.
i) What is the effective annual rate on your loan?
ii) Assume you can claim the interest on this loan as a tax deduction against the rental income you receive from the property. How much interest will you be able to claim as an annual tax deduction in the first financial year (1 July 2014 to 30 June 2015) and in the fifth financial year?
3. In December 2014, Moody's Chief Economist John Lonski said in reference to US high-yield bonds
i) Explain which component(s) of market interest rates account for high-yield bonds having such large spreads over the yield on a Treasury bond of equivalent maturity and why a 'positive outlook for business activity' would have an impact on those spreads.
(Lonski, J. 2014, 'Credit Markets Review and Outlook: Foreign deflation risks menace 2015's benign outlook for corporate credit', Weekly Market Outlook, Moody's Analytics, 18 December, p. 3. )
ii) What would happen to the prices of high yield bonds if Lonski's prediction is correct? Illustrate your answer with a numerical example for a high-yield bond with 10 years to maturity and 8% semi-annual coupon payments. Assume a 10 year Treasury bond yields 2.14% p.a.