Question

Calculate the discount factors (present value factors) at 8% for years 1, 2, 3, and 4 (show all work, including equations). Given your answer, aside for the math reasoning, why would economists claim that discount count factors must decline? Must that be true? Explain fully.

What if the df for year 3 above is equal to .900. Would that provide arbitrage opportunities? Explain fully.

Answer 1

page-01 gnswer from the problem Calculate the discount factors at 84: fe years 1, 2, 3 and present value factor - Cint where re interest rate to time period. pv foeter for iyuer {1+0.08)' 1.08 = 0.9959 pv factor for year a a .. (1 +0.08) - 1.1664 = 0.85-13 pv factor for years 1170.08) 11.083 T12597

0.7938 page : 02 pr factor for year 4 - 46.0254 - 1.3604 1.3604 = 0.7349 Discount fartais are declining due to the concept of time value of money. in fisast year discunt factor is 0.9259 but it is 0.8543 for year a. This is because first discount factor applies for only I year, but next time it is applied for 2 years. . faplaining discount factor for geoom 3 above is equal to 0.900 what would provide arbitrage oppurtunities inf discount factor for years is equal to 0.900 0,900 = deltogs re 3.571. ; : 30, This provides arbitrage opportunity as then one can borrow at 3.541. and invest at oil interest rate -