# Unit 15 help!

Registered Posts: 5 Regular contributor ⭐ ? ⭐
Ive just been struggling with 2 parts of Unit 15:

I understand what debt factoring is but what is invoice discounting? I cant see the difference?

Also in the book it says:
On 26 January 2006 the quoted price of 9% Treasury 2008 was £111.63. This means that £100 of the gilts can be purchased for £111.63. The security will be redeemed in 2008 at its nominal value of £100 and the closer the gilt gets to its maturity date the price will move towards £100

I really dont get this at all??

Thankyou for any help,
James

• Registered Posts: 218 ? ? ?
See the following web link for

The difference between Debt factoring and Invoice discounting

go to the bottom of the page and explore the topic in depth

"On 26 January 2006 the quoted price of 9% Treasury 2008 was £111.63. This means that £100 of the gilts can be purchased for £111.63. The security will be redeemed in 2008 at its nominal value of £100 and the closer the gilt gets to its maturity date the price will move towards £100"

Let us understand the basic theory of how the treasury gilts work. Based on the above 9% treasury 2008; means that the investor will get 9% fixed interest on the investment every year until year 2008 when the investor will be repaid the original amount invested on maturity date.

Investments are normally issued in bonds at a face value of £100 each; thus £9 is payable in interest on each bond every year.

Now let’s look at the simple mechanism;

At current interest of 9% on £100 interest earned equals £9 and the investment value equals £100

What would happen if the interest rate rises to 10%
9% treasury 2008 STOCK will earn £9 in interest.

Calculation:
£9 now equals to 10%. Therefore £9 divide by 10 times 100 = £90

At new interest rate of 10% on £100; interest earned equals £9 and the investment value equals £90

Therefore the market value of the bond has fallen by £10 from £100 to £90. The investor has lost 10% of his investment as a result of 1% rise in the interest rate.

What would happen if the interest rate falls to 7.5 %
Calculation:
£9 now equals to 7.5%. Therefore £9 divide by 7.5 times 100 = £120

At new interest rate of 7.5% on £100; interest earned equals £9 and the investment value equals £120

Therefore the market value of the bond has risen by £20 from £100 to £120. The investor has gained 20% on his investment as a result of 1.5% fall in the interest rate.

What is the current interest rate if the market value of the bond is £111.63

As the value of the bond has gone up to £111.63 the interest rate MUST have fallen.

Calculation:
£9 divide by £110.63 times 100% = 8% (rounded down)

The interest rate has fallen by 1% to 8% and the value of the bond increased by £11.63

However the above is a simplistic view for understanding.

Based on the above calculations would an investor pay £111.63 at the beginning of the year 2008 to receive £9 interest and the bond face value of £100 at the end of the year? Not only the investor will not receive any interest but make an obvious loss of £2.63 at the end of the year.

Therefore the market price of the bond must consist of an INTRINSIC value and a TIME value elements in it’s calculation of the Bond price.

The long term bonds (over 25 years) will have a higher intrinsic value and a lower time value elements of the bond price while the short term will have a high time value and a lower intrinsic value.

(The calculations are complicated and not necessary to understand for AAT purposes.)

Therefore the market price of the gilt will come closer to £100 when it comes nearer to the maturity date because on maturity both the intrinsic and time value will be nil.