Suppose Preun Inc. issues $200 million in 60 day maturity commercial paper at a price of 99.35 par. (commercial paper is like a zero coupon bond. You buy it at a price of less than its par value and it pays the investor par value at the maturity date.) It then uses this money to invest in short term securities yielding 4.8%. What is Preun's annualized rate of return on this strategy?
To calculate Preun Inc.'s annualized rate of return on this strategy, we first need to determine the amount of interest earned on the short-term securities.
The formula to calculate the interest earned is:
Interest Earned = Principal x Rate x Time
Here, the principal amount is $200 million (the amount raised through issuing commercial paper), the rate is 4.8% (the yield on the short-term securities), and the time is 60 days.
Converting 60 days to a fraction of a year, we divide by 365:
Time in Years = 60 / 365
Now, let's calculate the interest earned:
Interest Earned = $200,000,000 x 0.048 x (60 / 365)
Next, we need to subtract the discount paid on the commercial paper. The discount is the difference between the price at which the paper was issued (99.35 par) and its par value (100).
Discount = Par Value - Issued Price
Discount = 100 - 99.35
Discount = 0.65
Lastly, we can calculate Preun Inc.'s annualized rate of return on this strategy using the following formula:
Annualized Rate of Return = (Interest Earned - Discount) / Issued Price
Plug in the values to find the answer.