1. Which of the following investment that pay $6500 in four years will have a hi

Question

1. Which of the following investment that pay $6500 in four years will have a higher price today? Assume that both investments have equal risk.

a. The security that earns an interest rate of 11.50%

b. The security that earns an interest rate of 17.25%

2. Earic wants to invest in government securities that promise to pay $1000 at a maturity. The opportunity cost (interest rate) of holding the security is 4.00% . Assuming that both investment have equal risk and Earic's investment time horizon is flexible , which of the following investment option is priced lower?

a. An investment that matures in four years

b. An investment that matures in three years

Explanation / Answer

Solution 1:

The security gthat earns an interest rate of 11.50 % will price higher today because the price after 4 years needs to be discounted at the interest rate and lesser the interest rate lesser the discount factor hence the answer is option a

Solution 2:

An investment option which matures in 4 years would be priced lower because the discount factor for 4 years at 4 % would be more then the discount factor for 3 years and hence dividing the factor with the current price it becomes the lower price investment .

Thank you.

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