1. Question 1
Would a dollar tomorrow be worth more to you today when the interest rate is 20% or 10%? PV = CF/(1 + i)
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2. Question 1 and Answer
Would a dollar tomorrow be worth more to you today when the interest rate is 20% or 10%? PV = CF/(1 + i) Less. It would be worth 1/( ) = $0.83 when the interest rate is 20%, rather than 1/( ) =$0.91 when the interest rate is 10%.
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3. Question 2: What is the yield to maturity on a $1,000 Face-value discount bond maturing in 1 year that sells for $800?
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4. Question 2: What is the yield to maturity on a $1,000 Face-value discount bond maturing in 1 year that sells for $800?
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5. Question 3
Which $1,000 bond has the higher yield to maturity, a 20 year bond selling for $800 with a current yield of 15% or a 1 year bond selling for $800 with a current yield of 5%?
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6. Question 3 and Answer
Which $1,000 bond has the higher yield to maturity, a 20 year bond selling for $800 with a current yield of 15% or a 1 year bond selling for $800 with a current yield of 5%? If the one-year bond did not have a coupon payment, its yield to maturity would be ($1,000 − $800)/$800 − $200/$800 = 0.25 = 25%. Because it does have a coupon payment, its yield to maturity must be greater than 25%. However, because the current yield is a good approximation of the yield to maturity for a twenty-year bond, we know that the yield to maturity on this bond is approximately 15%. Therefore, the one-year bond has a higher yield to maturity.
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7. Question 4
You have just won $10 million in the lottery, which promises to pay you $1 million every year for the next 10 years. Have you really won $10 million?
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8. Question 4 and Answer
You have just won $10 million in the lottery, which promises to pay you $1 million every year for the next 10 years. Have you really won $10 million?
Assuming a 5% interest rate the present value would make payment only worth a little over $7 million.
On excel:
=PV(rate-.05, # of payments-9, payment amount-$1,000,000, future value-0) =
$7,107,821.68
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9. Question 5
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10. Question 5 and Answer
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11. Question 6
If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?
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12. Calculating Interest Rates (Cont.) p. 61
Nominal Versus Real Interest Rates
Nominal Interest Rates—Money amount of interest received
Real Interest Rates—Purchasing power of interest received
Real interest rate is the nominal interest adjusted for inflation
Real interest rate = Nominal rate – Inflation rate
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13. Question 6 and Answer
If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?
People are more likely to buy houses because the real interest rate when purchasing a house has fallen 3 percent (5 percent − 2 percent) to 1 percent (10 percent − 9 percent). The real cost of financing the house is thus lower, even though mortgage rates have risen.
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