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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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/(1 + 0.20) =
$0.83 when the interest rate is 20%,
rather than
1/(1 + 0.10) =$0.91 when the interest
rate is 10%.

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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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 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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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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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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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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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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Question 5
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Question 5 and Answer
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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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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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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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