5-9, 5-10, 5-11, 5-12, 5-13, 5-14, 5-15, 5-16, 6-2, 6-3, 6-4, 6-5, 6-6 and 6-7,

PRESENT AND FUTURE VALUES FOR DIFFERENT PERIODS Find the following values using
the equations and then a financial calculator. Compounding/discounting occurs annually.
a. An initial $500 compounded for 1 year at 6%
b. An initial $500 compounded for 2 years at 6%
c. The present value of $500 due in 1 year at a discount rate of 6%
d. The present value of $500 due in 2 years at a discount rate of 6%

a. An initial $500 compounded for 1 year at 6%

FV $530
b. An initial $500 compounded for 2 years at 6%
FV $562
c. The present value of $500 due in 1 year at a discount rate of 6%
PV $471.70
d. The present value of $500 due in 2 years at a discount rate of 6%
PV $445.00
30
PRESENT AND FUTURE VALUES FOR DIFFERENT INTEREST RATES Find the following
values. Compounding/discounting occurs annually.
a. An initial $500 compounded for 10 years at 6%
b. An initial $500 compounded for 10 years at 12%
c. The present value of $500 due in 10 years at 6%
d. The present value of $1,552.90 due in 10 years at 12% and at 6%
e. Define present value and illustrate it using a time line with data from Part d. How are present values affected by interest rate

a. An initial $500 compounded for 10 years at 6%

FV $895.42

b. An initial $500 compounded for 10 years at 12%

FV $1,006.10

c. The present value of $500 due in 10 years at 6%

PV $279.20

d. The present value of $1,552.90 due in 10 years at 12% and at 6%

PV@6% $867.13
PV@12% $499.99

e. Define present value and illustrate it using a time line with data from Part d. How are present values affected by interest rate
PV FV
INT @ 6% 500 ----- 10Years -------- 1552.9

PV FV
INT @ 6% 867.13 ----- 10Years -------- 1552.9
values affected by interest rates?

values affected by interest rates?

GROWTH RATES Shalit Corporations 2008 sales were $12 million. Its 2003 sales were
$6 million.
a. At what rate have sales been growing?
b. Suppose someone made this statement: Sales doubled in 5 years. This represents a
growth of 100% in 5 years; so dividing 100% by 5, we find the growth rate to be
20% per year. Is that statement correct?

Sales 2003 2008

6 12

N 5
PV 6
FV 12
I ?

Growth Rate 0.189207

Growth Rate 18.92%

B) The sales is growing at 19% per year so the statement is incorrect.

EFFECTIVE RATE OF INTEREST Find the interest rates earned on each of the following:
a. You borrow $700 and promise to pay back $749 at the end of 1 year.
b. You lend $700 and the borrower promises to pay you $749 at the end of 1 year.
c. You borrow $85,000 and promise to pay back $201,229 at the end of 10 years.
d. You borrow $9,000 and promise to make payments of $2,684.80 at the end of each year for 5 years.

a. You borrow $700 and promise to pay back $749 at the end of 1 year.
Int 0.68%

b. You lend $700 and the borrower promises to pay you $749 at the end of 1 year.
Int 0.68%

c. You borrow $85,000 and promise to pay back $201,229 at the end of 10 years.
Int 37.22%

d. You borrow $9,000 and promise to make payments of $2,684.80 at the end of each year for 5 years.
Int 15.00%
TIME FOR A LUMP SUM TO DOUBLE How long will it take $200 to double if it earns the
following rates? Compounding occurs once a year.
a. 7%
b. 10%
c. 18%
d. 100%

PV 200
FV 400

a. 7%
No of Years 10
b. 10%
No of Years 7
c. 18%
No of Years 4
d. 100%
No of Years 1
FUTURE VALUE OF AN ANNUITY Find the future values of these ordinary annuities.
Compounding occurs once a year.
a. $400 per year for 10 years at 10%
b. $200 per year for 5 years at 5%
c. $400 per year for 5 years at 0%
d. Rework Parts a, b, and c assuming they are annuities due.

a. $400 per year for 10 years at 10%

FVA $6,374.97

b. $200 per year for 5 years at 5%

FVA $1,105.13

c. $400 per year for 5 years at 0%

FVA $2,000.00

d. Rework Parts a, b, and c assuming they are annuities due.

a. $400 per year for 10 years at 10%

FVA $7,012.47
b. $200 per year for 5 years at 5%
FVA $1,160.38
c. $400 per year for 5 years at 0%
FVA $2,000.00
PRESENT VALUE OF AN ANNUITY Find the present values of these ordinary annuities.
Discounting occurs once a year.
a. $400 per year for 10 years at 10%
b. $200 per year for 5 years at 5%
c. $400 per year for 5 years at 0%
d. Rework Parts a, b, and c assuming they are annuities due.

a. $400 per year for 10 years at 10%

PVA $2,457.83

b. $200 per year for 5 years at 5%

PVA $865.90

c. $400 per year for 5 years at 0%

PVA $2,000.00

d. Rework Parts a, b, and c assuming they are annuities due.

a. $400 per year for 10 years at 10%

PVA $2,703.61

b. $200 per year for 5 years at 5%

PVA $909.19

c. $400 per year for 5 years at 0%

PVA $2,000.00
PRESENT VALUE OF A PERPETUITY What is the present value of a $100 perpetuity if the
interest rate is 7%? If interest rates doubled to 14%, what would its present value be?

INT-7%
PVA 1428.571

INT-14%
PVA 714.2857
REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently
yielding 5.5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the
following estimates of current interest rate premiums:
l Inflation premium= 3.25%
l Liquidity premium = 0.6%
l Maturity risk premium = 1.8%
l Default risk premium = 2.15%
On the basis of these data, what is the real risk-free rate of return?

r= r* + IP + DRP + LP + MRP
required return on a debt security r
real risk-free rate of interest r*
inflation premium IP
default risk premium DRP
liquidity premium LP
maturity risk premium MRP

real risk-free rate of interest -2.30%

 6%
?
3.25%
2.15%
0.60%
1.80%
EXPECTED INTEREST RATE The real risk-free rate is 3%. Inflation is expected to be 2%
this year and 4% during the next 2 years. Assume that the maturity risk premium is zero.
What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury
securities?

r= r* + IP + DRP + LP + MRP
required return on a debt security r
real risk-free rate of interest r* 3
inflation premium IP 2
maturity risk premium MRP 0

Expected Yield for 2 Year T-Sec 6%

Expected Yield for 2 Year T-Sec 6%
 2- Year T-S 3- Year T-Sec
AVG IP 3 3.333333
DEFAULT RISK PREMIUM A Treasury bond that matures in 10 years has a yield of 6%. A
10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the
corporate bond is 0.5%. What is the default risk premium on the corporate bond?

r= r* + IP + DRP + LP + MRP
required return on a debt security r
real risk-free rate of interest r*
inflation premium IP
default risk premium DRP
liquidity premium LP
maturity risk premium MRP

DRP
%
8
-
--
?
0.5
6

1.5
MATURITY RISK PREMIUM The real risk-free rate is 3%, and inflation is expected to be 3%
for the next 2 years. A 2-year Treasury security yields 6.2%. What is the maturity risk
premium for the 2-year security?

r= r* + IP + DRP + LP + MRP %
required return on a debt security r 6.2
real risk-free rate of interest r* 3
inflation premium IP 3
default risk premium DRP --
liquidity premium LP --
maturity risk premium MRP ?

MRP 0.2
INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation
where the inflation rate is very high. As a result, the analyst has been warned not to ignore
the cross-product between the real rate and inflation. If the real risk-free rate is 5% and
inflation is expected to be 16% each of the next 4 years, what is the yield on a 4-year security
with no maturity, default, or liquidity risk? (Hint: Refer to The Links between Expected
Inflation and Interest Rates: A Closer Look on Page 178.)

rRF (1+R*)(1+I)-1

r* 0.05
IP 0.16 1.05 1.218 22%
r ? 1.16

rRF 0.218

The yield on 4-year security in 21.8%

EXPECTATIONS THEORY One-year Treasury securities yield 5%. The market anticipates
that 1 year from now, 1-year Treasury securities will yield 6%. If the pure expectations
theory is correct, what is the yield today for 2-year Treasury securities?

Maturity Yield
1 year 5%
2 year 6%

6%=(5%+X)/2 X=(6*2)-5
7.00

As per pure expectgtion theory the yield today for 2 yr T-Sec is 7%