2. Market interest rates have suddenly changed from when you worked out Problem 1 above. Prior to your lending ten dollars to him, your same classmate decides that he doesn't want to repay you the principal and interest (face value F₁ of his bond) in one week, but would prefer to spread the total repayment out over two weeks. He offers you an opportunity to lend him some dollars today, but in return he will repay you something one week from today and the rest exactly two weeks from today. After some hard-fought negotiations, you reach an agreement with him to repay you $1.00 one week from today and $11.45 two weeks from today but both you and he need to determine the market price (principal) Bo of the bond (loan) today before he's willing to borrow from you. a. If you agree to loan him $9.00 today, is there a single "interest rate" for this loan? If so, what is it? b. Now both you and he observe that one dollar today will buy a riskless one week loan with a face value F₁ of $1.01 or a two week loan with a face value of F₂ = $1.04. For the repayments he's offered you, what amount would you loan him today for the bond (loan) he wants?
2. Market interest rates have suddenly changed from when you worked out Problem 1 above. Prior to your lending ten dollars to him, your same classmate decides that he doesn't want to repay you the principal and interest (face value F₁ of his bond) in one week, but would prefer to spread the total repayment out over two weeks. He offers you an opportunity to lend him some dollars today, but in return he will repay you something one week from today and the rest exactly two weeks from today. After some hard-fought negotiations, you reach an agreement with him to repay you $1.00 one week from today and $11.45 two weeks from today but both you and he need to determine the market price (principal) Bo of the bond (loan) today before he's willing to borrow from you. a. If you agree to loan him $9.00 today, is there a single "interest rate" for this loan? If so, what is it? b. Now both you and he observe that one dollar today will buy a riskless one week loan with a face value F₁ of $1.01 or a two week loan with a face value of F₂ = $1.04. For the repayments he's offered you, what amount would you loan him today for the bond (loan) he wants?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Answer 2 required. Answer 1 has been attached.
Transcribed Image Text:It is given that you will give $10 loan to our class mate and will get $12 in one week.
Answer (a)
Value of $12 in one week is equal to $10 today.
Hence Value of $1 in one week = $10/$12 = $ 0.83 today
Hence value of a dollar today as measured In dollars In One week = $0.83
Answer (b)
Value of $10 today is equal to $12 in One week
Hence Value of $1 today = $12 / $10 = $1.20 in One week
Hence Value of a dollar In one week as measured In dollars today= $1.20
Answer (c)
The term "Present value "is used in finance for the relative price determined in (a)
Answer (d)
The term "Future value "is used in finance for the relative price determined in (b).
Transcribed Image Text:1. Your classmate asks you for a loan of $10.00.00 today in exchange for promising you a repayment of
$12.00 in one week. You agree to make the loan, knowing that he always carries out his promises.
a. What is the value of a dollar today as measured in dollars in one week?
b. What is the value of a dollar in one week as measured in dollars today?
c. What term is used in finance for the relative price determined in (a)?
d. What term is used in finance for the relative price determined in (b)?
2. Market interest rates have suddenly changed from when you worked out Problem 1 above. Prior to your
lending ten dollars to him, your same classmate decides that he doesn't want to repay you the principal
and interest (face value Fi of his bond) in one week, but would prefer to spread the total repayment
out over two weeks. He offers you an opportunity to lend him some dollars today, but in return he
will repay you something one week from today and the rest exactly two weeks from today. After some
hard-fought negotiations, you reach an agreement with him to repay you $1.00 one week from today
and $11.45 two weeks from today but both you and he need to determine the market price (principal)
Bo of the bond (loan) today before he's willing to borrow from you.
a. If you agree to loan him $9.00 today, is there a single "interest rate" for this loan? If so, what is it?
b. Now both you and he observe that one dollar today will buy a riskless one week loan with a face
value Fi of $1.01 or a two week loan with a face value of F2 = $1.04. For the repayments he's
offered you, what amount would you loan him today for the bond (loan) he wants?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 3 steps
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education