ECON 110 Chapter Notes - Chapter 28: Shortage, Capital Outflow, Canadian Dollar

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Chapter 28: money, interest rates, and economic activity. Present value (pv) is the value now of one or more payments to be made in the future: depends on the current interest rate to determine the present value. R1 is the amount we receive one year from now, i is the annual interest rate: present value = r1 (1+i) R1 = first payment, r2 = second payment, rt = final payment + fv of bond. The exponent is the period (1=payment in first period, 2 = second, etc. ) i = is the annual interest rate. An increase in the market interest rate leads to a fall in the price of any given bond. A decrease in the market interest rate leads in an increase in the price of any given bond. As the price of the bond drops due to increasing market rates, your yield increases: investment costs less but you have the same rate of return.

Related Questions

139.The present value of a future payment increases if the:
A) period between the present and the future increases.
B) future payment decreases.
C) interest rate decreases.
D) stock market falls

140. The present value of a future payment decreases if the:
A) period between the present and the future increases.
B) future payment increases.
C) interest rate decreases.
D) stock market rises.

141. The present value of future payments depends on:
A) the size of the payment.
B) the length of the time period.
C) the interest rate.
D) all of the above.

142. Given an interest rate of 3 percent, the present value of afuture payment of $2,080 to be paid in one year is:
A) $1,904.76
B) $2,000.00
C) $2,019.42
D) $2,080.00

I am having problems with this problem from my Econcoursework. Iunderstand how to do parts 1 and 2, but amhaving trouble with parts3 and 4. For part 3, how do I dothe calculation for an infiniteperiod? As the time becomeslonger the present value goes to zero,so do i assume a period, oris there an actual method for infiniteperiods? For part 4,do I simply do the sum for the future value andplug it into thePresent value equation? Not really looking for thesolutionhere, but I need some help getting the third and fourthpartssolved.

Congratulations! You just won the lottery! You can elect toreceiveyour prize in one of four
payment streams:
(i) $1,000,000 now
(ii) $1,500,000 at the end of five years
(iii) $60,000 per year in perpetuity (for ever), with paymentsmadeat the end of each year (so your
first payment comes one year from today)
(iv) $150,000 per year for the next ten years, with payments madeatthe end of each year (so your
first payment comes one year from today)

Suppose the annual interest rate is 5% with certainty andinperpetuity. Calculate the present value of
each of the four payment options (i.e., in todayâs dollars).Rankfor four options from most to least
valuable. You can use Excel or a calculator to solve this, butyoumust show the formulas you use.

Suppose that a major city's main thoroughfare, which is also an interstate highway, will be completely closed to traffic for two years from January 2012 to December 2013 for reconstruction, at a cost of $535 million. If the construction company were to keep the highway open for traffic during construction, the highway reconstruction project would take much longer and be more expensive. Suppose that construction would take four years if the highway were kept open, at a total cost of $800 million. The state department of transportation had to make its decision in 2011, one year before the start of construction (so that the first payment was one year away). The department of transportation had the following choices:

(i) Close the highway during construction, at an annual cost of $280 million per year for two years.

(ii) Keep the highway open during construction, at an annual cost of $200 million per year for four years.

a. Suppose the interest rate is 8%. Calculate the present value of the costs incurred under each plan. Which reconstruction plan is less expensive?

b. Now suppose the interest rate is 16%. Calculate the present value of the costs incurred under each plan. Which reconstruction plan is now less expensive?

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ECON 110 Chapter Notes - Chapter 28: Shortage, Capital Outflow, Canadian Dollar

ECON 110 Full Course Notes

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