Question

Suppose the risk-free interest rate is 5%.

(a) Having $400 today is equivalent to having  $Answer in one year? (Round to the nearest cent.)

(b) Having $400 in one year is equivalent to having $Answer today? (Round to the nearest cent.)

(c) Which would you prefer, $400 today or $400 in one year?

$400 today

$400 in one year

(d) Does your answer depend on when you need the money? Why or why not?

Yes, because if you didn't need it, it would not be worth $400.

Yes, because if you did need the money today it would be more valuable than $400.

No, because if you didn't need it then the $400 could be invested and would be worth more than $400 in one year.

No, because if you did need it you could borrow $400 today.

Answer 1

a)
Given:
Risk free interest rate	5%
Money today	$400
a)
$ amount in one year would we the Money today + interest earned in an year @ 5%
Interest for the Year = $400*5%
Interest for the Year = $20
$ amount in a year = $400+$20
$ amount in a year = $420
b)
Given:
Value after an Year i.e FV	$400
Rate i.e the discounting rate	5%
To calculate value today we would multiply the discounting factor for year 1 and $ value after an year
Discounting factor for year 1 = (1/1.05^1) = 0.952380952
$ Value today = Discounting factor * $ value after and year
0.952380952380952*$400
380.952381
$ value today = $380.95
Having $400 in one year is equivalent to having $380.95 today
c)
We would prefer $400 today ,because having $400 today given us an opportunity to earn interest ,
therefore creating a value of additional $20 in an year, and the value of $400 would be $420
d)
No, because if you didn't need it then the $400 could be invested and would be worth more than $400 in one year.