To help pay for college, you have just taken out a $10,000 government loan that

Question

To help pay for college, you have just taken out a $10,000 government loan that makes you pay $1,260 per year for 25 years. However, you don’t have to start making these payments until you graduate from college two years from now. Is the yield to maturity less than 12%? (12% is the yield to maturity on a normal $1,0000 fixed-payment loan on which you pay $1,260 per year for 25 years.) Why? (Hint: you don’t need to calculate the yield to maturity to answer this question.) To help pay for college, you have just taken out a $10,000 government loan that makes you pay $1,260 per year for 25 years. However, you don’t have to start making these payments until you graduate from college two years from now. Is the yield to maturity less than 12%? (12% is the yield to maturity on a normal $1,0000 fixed-payment loan on which you pay $1,260 per year for 25 years.) Why? (Hint: you don’t need to calculate the yield to maturity to answer this question.)

Explanation / Answer

ANSWER:

If the interest rate was 12% , the present value of the payments will be less then the $10,000 loan amount as they do not start for 2 years on the government loan and therefore the yield to maturity must be lower then 12% in order for the present value of the payments to add up to $10,000.

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