2. Ingrid wants to treat herself and buy a new car when she graduates in 4 years

Question

2. Ingrid wants to treat herself and buy a new car when she graduates in 4 years. She estimates that at the end of 4 years, she will need $25,000 to purchase the car that she wants. She has saved $15,000 so far. What interest rate does she need to achieve for a four year investment in order to realize this dream?

3. The current rate of return on a one-year U.S. Government security is 3%. The rate of return on a two-year U.S. Government security is 5%. According to the expectations theory, what is the return on a one-year U.S. Government security purchased one year from today?

Explanation / Answer

Question 2

We have

Present Value = Future value * [1/ (1+Rate per period)^no. of periods]

15000 = 25000 * [1/(1+r)^4]

(1+r)^4 = 25000 /15000

=1 .6667

1+r = 1.6667^1/4

= 1.6667^.25

= 1.1362

r = 1.1362-1

= .1362

r = 13.62%

Question 3

Let r be the return on a one-year U.S. Government security purchased one year from today.

(1+current 1 year rate)*(1+r) = (1+current 2 year rate)^2

(1.03)*(1+r) = 1.05^2

1+r = 1.1025/1.03

= 1.0704

r = 1.0704-1

= .0704

r = 7.04%

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