FUNDAMENTAL CONCEPTS IN FINANCIAL MANAGEMENT
Do time lines deal only with years or could other periods be used?
Set up a time line to illustrate the following situation: You currently have $2,000 in a three-year certificate of deposit (CD) that pays a guaranteed 4 percent annually.
What is “discounting,” and how is it related to compounding? How is the future value equation (2-1) related to the present value equation (2-2)? How does the present value of a future payment change as the time to receipt is lengthened? As the interest rate increases?
Suppose a U.S. government bond promises to pay $2,249.73 three years from now. If the going interest rate on three-year government bonds is 4 percent, how much is the bond worth today? How would your answer change if the bond matured in five rather than three years? What if the interest rate on the five-year bond were 6 percent
rather than 4 percent? ($2,000; $1,849.11; $1,681.13)
How much would $1,000,000 due in 100 years be worth today if the discount rate were 5 percent? If the discount rate were 20 percent? ($7,604.49; $0.0121)
The U.S. Treasury offers to sell you a bond for $585.43. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond for $585.43? What rate would you earn if you could buy the bond for $550? For $600? (5.5%; 6.16%; 5.24%) Microsoft earned $0.12 per share in 1994. Ten years later, in 2004, it earned $1.04. What was the growth rate in Microsoft’s earnings per share (EPS) over the 10-year period? If EPS in 2004 had been $0.65 rather than $1.04, what would the growth rate have been? (24.1%; 18.41%)
What’s the difference between an ordinary annuity and an annuity due?
Why should you rather receive an annuity due for $10,000 per year for 10 years than an otherwise similar ordinary annuity?
For an ordinary annuity with five annual payments of $100 and a 10 percent interest rate, how many years will the first payment earn interest, and what will this payment’s value be at the end? Answer this same question for the fifth payment. (4 years, $146.41; 0 years, $100)
Assume that you plan to buy a condo five years from now, and you estimate that you can save $2,500 per year. You plan to deposit the money in a bank that pays 4 percent interest, and you will make the first deposit at the end of the year. How much will you have after five years? How would your answer change if the interest rate were increased to 6 percent, or lowered to 3 percent? ($13,540.81; $14,092.73; $13,272.84)
