I will require 100 U in three years. I will receive 12% per year at the bank. How much should I deposit now so that I obtain the appropriate amount in 3 years?
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This can be calculated as:
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Now suppose that the interest is compounded monthly. The calculation proceeds as follows:
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The effect of the compounding over shorter periods is easily seen.
I have been offered a zero-level bond paying 1000 U in 5 years for 800 U. The risk of default is nil. Should I buy the bond if the interest rate is 10%?
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Answer: it is definitely not a good deal. The bond would be yielding
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about 4.6 %