1. You expect to have $20,000 in one year. A bank is offering loans at 4% interest...

1. You expect to have $20,000 in one year. A bank is offering loans at 4% interest per year. How much can you borrow?

2. Your friend’s mom is thinking of retiring. Her retirement plan will pay her either $225,000 immediately or $325,000 five years after the date of her retirement. Which alternative should she choose if the interest rate is a. 0% per year? b. 8% per year? c. 20% per year?

a. 0% per year? b. 8% per year? c. 20% per year?

3. You are considering a savings bond that will pay $200 in 10 years. If the interest rate is 2%, what should you pay today for the bond?

Solutions

Expert Solution

1]	The amount that can be borrowed is the PV of $20,000
	discounted at 4%, for 1 year = 20000/1.04 =	$ 19,231
2]	The PV of the amount to be received after 5 years:
	a] If the discount rate is %--no discounting required =	$ 3,25,000
	b] If the discount rate is 8% = 325000/1.08^5 =	$ 2,21,190
	c] If the discount rate is 20% = 325000/1.2^5 =	$ 1,30,610
	CHOICE:
	The PV of immediate receipt is $225,000. She should chose
	either receiving immediately or the deferred payment
	which ever has higher PV. Accordingly,
	a] She should choose receiving $325,000 after five years
	b] She should choose receiving $225,000 now
	c] She should choose receiving $225,000 now
3]	Amount that can be paid = 200/1.02^10 =	$ 164

jeff jeffy answered 1 year ago

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