## What is the duration of this bond?

Chapter 15 — Working Capital Management

PROBLEM 1

On a typical day, Park Place Clinic writes $1,000 in checks. It

generally takes four days for those checks to clear. Each day the

clinic typically receives $1,000 in checks that take three days to

clear. What is the clinic’s average net float?

PROBLEM 2

Drugs ‘R Us operates a mail order pharmaceutical business on the

West Coast. The firm receives an average of $325,000 in payments

per day. On average, it takes four days for the firm to receive

payment, from the time customers mail their checks to the time the

firm receives and processes them. A lockbox system that consists of

ten local depository banks and a concentration bank in San

Francisco would cost $6,500 per month. Under this system,

customers’ checks would be received at the lockbox locations one

day after they are mailed, and the daily total would be wired to

the concentration bank at a cost of $9.75 each. Assume that the

firm can earn 10 percent on marketable securities and that there

are 260 working days and hence 260 transfers from each of the ten

lockbox locations per year.

What is the total annual cost of operating the lockbox

system?

What is the dollar benefit of the system to Drugs’R Us?

Should the firm initiate the lockbox system?

PROBLEM 3

Suppose one of the suppliers to Seattle Health System offers

terms of 3/20, net 60.

When does the system have to pay its bills from this

supplier?

What is the approximate cost of the costly trade credit offered

by this supplier? (Assume 360 days per year.)

Chapter 18 — Financial Risk Management

PROBLEM 1

Pleasant View Nursing Home estimates that its building will last

another ten years and then it will need to be replaced. The home

estimates that the capital cost of a new building in ten years will

be $10 million. The home plans to set aside a portion of an

endowment fund in government bonds to ensure it has sufficient

funds to pay for the replacement of the building. If we assume that the

yield curve is horizontal, the current interest rate on all

Treasury securities is 9 percent, and the type of security used for

the building fund is Treasury bonds, then the present value of $10

million discounted back ten years at 9 percent is $4,224,108.

Suppose interest rates change from the current 9 percent rate

immediately after the nursing home has bought the Treasury bonds.

What would be the value of the bonds at the end of ten years under

each of the following situations? (For simplicity, assume annual

coupons).

The home buys $4,224,108 of 9 percent, ten-year maturity bonds;

rates fall to 7 percent immediately after the purchase and remain

at that level; rates rise to 12 percent.

The home buys $4,224,108 of 9 percent, 40-year maturity bonds;

rates fall to 7 percent immediately after the purchase and remain

at that level; rates rise to 12 percent.

PROBLEM 2

Pleasant View Nursing Home has decided to immunize its portfolio

against interest rate and reinvestment rate risk by buying a bond

that has a duration equal to the years until the funds will be

needed (approximately ten years from today). The home is

considering a 20-year, 9 percent annual coupon bond bought at its

par value of $1,000.

What is the duration of this bond?

If the nursing home purchases $4,224,000 worth of this bond,

what would be the value of the bonds at the end of the duration

period if interest rates fall to 7 percent immediately after the

purchase and remain at that level? If interest rates rise to 12

percent?