ENGINEERING ECONOMICS ISE460 SESSION 9 CHAPTER 4, June 10, 2015 Geza P. Bottlik Page 1 OUTLINE...

ENGINEERING ECONOMICS ISE460SESSION 9

CHAPTER 4, June 10, 2015

Geza P. Bottlik

OUTLINE

• Questions?• News?• Recommendations• Next Homework• Chapter 4

– Mortgages– Bonds– Investments



Geza P. Bottlik

Recommendations

• Somerset House (by Waterloo bridge on North Bank)

– Wonderful art gallery, free to students (Courtauld gallery)

– Best collection of Rubens I have seen

– Terrific collection of impressionists and some Fauvists

– Huge courtyard with fountains

– Terrace with view of the river

• St. Mary’s church, just North of Somerset House

– Protestant churches are usually not open, this Anglican

one is from 10 -4 Tue-Thu. Interesting if you have never

been in one (I hadn’t)



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HOME MORTGAGE - EXAMPLES

• WITH OR WITHOUT POINTS

• MULTIPLE RATES

• VARIABLE RATE PEGGED TO ANOTHER RATE

– ARIZONA HOME EXAMPLE

• REFINANCING - DISCUSSION



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Example 1

• Borrow $100,000 for 15 years, making monthly payments

• Option 1: Interest rate of 6.375% APR, pay 1 point (%) that is subtracted

up front (you only get $99,000, but have to pay back $100,000)

• Option 2: Interest rate of 6.75% APR



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Example 2

• Borrowing $400,000

• Given 4 different interest rates

– The first three last 1 year each (3.125%, 3.75%, 4.25%)

– The fourth is for the balance of 27 years (4.75%)

• The assumption is that the borrowers ability to pay will increase during

the first few years

• What is the overall APR?



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VARIABLE RATES



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VARIABLE RATES

$400.00

$450.00

$500.00

$550.00

$600.00

$650.00

$700.00

$750.00

$800.00

7/11/89

7/11/90

7/11/91

7/11/92

7/11/93

7/11/94

7/11/95

7/11/96

7/11/97

7/11/98

7/11/99

7/11/00

7/11/01

7/11/02

7/11/03

7/11/04

7/11/05



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REFINANCING

• You borrowed $300,000 5 years ago at 4% APR for a term of 30

years and have been making regular payments

• Current interest rates are 3.75%

• You can refinance the loan for a fee of $3000 for another 30 years

• Should you refinance?



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BONDS

• ISSUED BY:

– COMPANIES

– FEDERAL GOVERNMENT (SAVINGS BONDS)

– STATE GOVERNMENTS

– MUNICIPAL GOVERNMENTS (USUALLY TAX FREE)



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BONDS (CONTINUED)

• DEFINITIONS

– MORTGAGE BONDS = BACKED BY SPECIFIC

COLLATERAL

– DEBENTURES = BACKED BY OVERALL ASSETS

• PAR VALUE = STATED FACE VALUE, DOES NOT CHANGE

• MATURITY DATE = DATE ON WHICH PAR VALUE WILL BE

REPAID

• COUPON RATE - INTEREST PAID ON THE PAR VALUE

– SEMIANNUAL PAYMENT IS USUAL , DOES NOT CHANGE



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BONDS (CONTINUED)

• DEFINITIONS (CONTINUED)

• DISCOUNT BOND - SOLD BELOW ITS PAR VALUE

• PREMIUM BOND - SOLD ABOVE ITS PAR VALUE

• MARKET PRICE - THE PRICE AT WHICH THE BOND IS

CURRENTLY BOUGHT AND SOLD

• THE VALUE OF A BOND IS DETERMINED BY THE PRESENT

VALUE OF THE REMAINING COUPONS AND THE PRESENT

VALUE OF THE FACE (PAR) VALUE AT MATURITY (ALSO

USED TO DETERMINE THE YIELD TO MATURITY)

• CURRENT YIELD – ANNUAL COUPONS DIVIDED BY THE

PRESENT PRICE



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Bond Example

• Face Value $1000

• Coupon Rate 5.5%, paid semiannually

• Date of Issue Jan 1, 2008

• Maturity 10 Years

• Prevailing interest rate 2%

• How much would you want to sell or buy this bond for?



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INVESTING

• LIQUIDITY – HOW QUICKLY YOU CAN GET AT YOUR MONEY

– FROM IN YOUR POCKET TO TIED UP IN A 35 YEAR MORTGAGE

(ALTHOUGH YOU COULD TRY AND SELL THE MORTGAGE)

• RISK – HOW LIKELY ARE YOU TO LOSE THE VALUE OF YOUR

ASSET

– FROM U.S. TREASURY BONDS TO BETTING ON HORSES

• RETURN – PROFIT OVER TIME

– SUM OF THREE FACTORS

1. “RISK FREE” REAL RETURN

2. INFLATION FACTOR

3. PREMIUM FOR RISK



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INVESTING

• RETURN (CONTINUED)

– COMPOUND

– AVERAGE ANNUAL RATE

– VOLATILITY – HOW MUCH DOES IT MOVE UP OR DOWN

– +’- $ OR %

– STANDARD DEVIATION = s ($ OR z)

» MEASURES PROBABILITY FROM THE MEAN

• +/- 1 s = 65%

• +/- 2 s = 95%

• +/- 3 s = 99%



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INVESTING

• STRATEGY – RISK VS. PAYOFF

– DOLLAR AVERAGING – INVEST AT A STEADY RATE

REGARDLESS OF PRICE

– DIVESIFICATION – SPREAD THE RISK AMONG MANY

DIFFERENT INVESTMENTS

– ASSET ALLOCATION- MOVE YOUR MONEY AMONG

DIFFERENT INVESTMENTS – THIS IS WHAT MONEY

MANAGERS DO



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DEFINITIONS

• MUTUAL FUND – POOLED MONEY IN MANY STOCKS

• STOCK – PART OWNERSHIP IN A COMPANY. YOU PAY A COMMISSION TO A BROKER TO BUY OR SELL A STOCK. THE PRICE DEPENDS ON WHAT OTHERS ARE WILLING TO PAY FOR IT

• DIVIDEND -- A PORTION OF THE PROFITS PAID TO THE OWNERS OF SHARES

• CAPITAL GAIN (LOSS) – WHAT YOU MAKE OR LOSE ON THE SALE OF AN ASSET HELD OVER 6 MONTHS

• SEE EXAMPLE 6.3 FOR AN ATTEMPT TO EVALUATE A STOCK (NOT ON THE SPREADSHEET DEMO)



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DEFINITIONS(CONTINUED)

• OPTION – AN OPPORTUNITY TO BUY A STOCK

– BUY PUT – TO BUY WITHIN A SPECIFIED TIME

– BUY CALL – TO BUY AT A GIVEN PRICE (STRIKE PRICE)

WITHIN A SPECIFIC TIME

– EXERCISE AN OPTION – BUY THE STOCK

ENGINEERING ECONOMICS ISE460 SESSION 9 CHAPTER 4, June 10, 2015 Geza P. Bottlik Page 1 OUTLINE...

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