Unit 15 help!

James777

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

visha

See the following web link for

The difference between Debt factoring and Invoice discounting

http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=1073791097&r.l1=1073858790&r.l3=1073924180&r.t=RESOURCES&r.i=1073791092&r.l2=1074453392&r.s=e

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

Your Quote

"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.