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# A has \$20,000.00. He/she has two options to make his/her

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VP
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A has \$20,000.00. He/she has two options to make his/her [#permalink]

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26 Feb 2005, 18:22
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A has \$20,000.00. He/she has two options to make his/her investment: Bond X offers 10% annual coupon intrate rate and Bond Y offers 15% annual coupon interest rate. A plans to make an annual income of \$4500, how much should he invest in X and Y?

Last edited by MA on 26 Feb 2005, 23:10, edited 1 time in total.

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VP
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26 Feb 2005, 18:34
Is he supposed to invest both X and Y and also I am assuming it is simple interest ?

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26 Feb 2005, 18:35
Logically, if you put all into Y@15%, you would make only 3k. Hence, you have to short sell X and leverage Y. This is assuming that he needs to make 4.5k over 1 year

.1X + .15[20,000 - X] = 4,500
X = -30,000
and Y = 50,000

Short 30k of X and buy 50k of Y
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Paul

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VP
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26 Feb 2005, 18:50
Paul wrote:
Logically, if you put all into Y@15%, you would make only 3k. Hence, you have to short sell X and leverage Y. This is assuming that he needs to make 4.5k over 1 year
.1X + .15[20,000 - X] = 4,500
X = -30,000 and Y = 50,000. Short 30k of X and buy 50k of Y

undoubtly excellent............. but prefer borrowing rather than short sell because short sell is for a very short period of time and borrowing can be done for any period of time.

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Manager
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26 Feb 2005, 18:59
I think the problem is easier if the answer choices are given, you just backsolve?.

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Manager
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26 Feb 2005, 19:57
In order to be able to sell something, first of all one needs to own that. We know that A has \$20K, how do we know that he owns Bond X to sell it? I think it should be stated in the question and not assumed.

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26 Feb 2005, 20:07
Marina wrote:
In order to be able to sell something, first of all one needs to own that. We know that A has \$20K, how do we know that he owns Bond X to sell it? I think it should be stated in the question and not assumed.

I agree with you. I think this is one of those finance concepts whereby one can "short sell" a securities one does not own. Since we are not talking about "borrowing" liquidity against a bank, I would still prefer the term "short selling", which can happen over a long time frame, although there is an inherent risk of having the instrument being "called" by the owner
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Paul

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VP
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26 Feb 2005, 20:25
Paul wrote:
Marina wrote:
In order to be able to sell something, first of all one needs to own that. We know that A has \$20K, how do we know that he owns Bond X to sell it? I think it should be stated in the question and not assumed.

I agree with you. I think this is one of those finance concepts whereby one can "short sell" a securities one does not own. Since we are not talking about "borrowing" liquidity against a bank, I would still prefer the term "short selling", which can happen over a long time frame, although there is an inherent risk of having the instrument being "called" by the owner

why i prefer borrowing is that in short selling the return doesnot belong to you while in borrowing the return belong to you.

to have short sell, you do not need to own something and to borrow aslo you do not need to own the assets to the extent of borrowing amts.

these concepts are totally practical in real life.

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SVP
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26 Feb 2005, 22:45
A good question (excellent explanation Paul), but not GMAT type, in my opinion. (It didn't specify A has to get 45k in one year, also didn't say that he has the option to sell short.)

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VP
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26 Feb 2005, 23:09
HongHu wrote:
A good question (excellent explanation Paul), but not GMAT type, in my opinion. (It didn't specify A has to get 45k in one year, also didn't say that he has the option to sell short.)

Yes, it is basically a finance concept (finance is my most favorite subject) and we need this concept to solve this problem. in perfectly competitive market, lending and borrowing are readily available.

Alright, i am editing the question as A plans to make \$4500 in one year. i agree with the notion that the GMAT question should be clear, if it is problem solving.

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26 Feb 2005, 23:09
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