Make a table and a diagram of the cash flows and then compute IRR.
1. (a) What is the effective annual cost to the borrower of a $500,000, 4%, 20-year, fully amortized home loan, repaid annually, if 2.5% in points (loan closing costs) is charged, and the loan is pre-paid at the end of 5 years with a 1.25% prepayment penalty? (What are the 3 cash flows at the end of 5?)
(b) What is the effective annual cost if the loan goes to maturity?
2. (a) A 4%, $1,000, 20-year, callable corporate bond is bought for $700. The corporation calls the bond (exercises the call option) after 5 years, and pays the par value plus a call premium equivalent to one-year’s coupon interest. Suppose annual coupon interest. What is the effective annual cost to the corporation?
(b) What is the effective cost if the bond goes to maturity?