As on 1st April, 2016, Russel Ltd. has surplus cash for six months. It has following two options under consideration for investing the surplus cash : (i) To invest in fixed deposit at an interest rate of 8% per annum pay
CS Executive · Capital Markets & Securities Laws · PYQS · December 2016
As on 1st April, 2016, Russel Ltd. has surplus cash for six months. It has following two options under consideration for investing the surplus cash : (i) To invest in fixed deposit at an interest rate of 8% per annum payable quarterly; or (ii) To buy treasury bills of the face value of ₹100 at ₹98.019 maturing after six months. Presuming that the risk involved in both the options is identical, state with reasons as to which option should be selected by the company for investing its surplus funds.
Answer & Explanation:
(i) Computation of Effective rate of interest Rate of interest = 8% per annum Quarterly rate of interest = 2% Effective rate of interest = [(1.02) 2 - 1]*100 = 4.04% (considering 6 months) (ii) Computation of yield of a Treasury bill Y = (100 - P) x 365 x 100 / (P x D) Wherein Y = Discounted yield P = Price D = Days to maturity. The days to maturity of Treasury bill are (April- 30 days, May-31 days, June- 30 days, July-31 days, August-31 days, September -30 days) = (100 - 98.019) x 365 x 100 / (98.019 x 183) = 4.03% Since the effective rate of interest on fixed deposit is more than the yield from T bill, it shall be advantageous to invest the money in fixed deposits.
Topics: Investment Analysis