problem set 2 solutions

problem set 2 solutions - Problem Set#2 Compounding...

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Problem Set #2 Compounding Frequency and Discounted Cash Flows 1. Fixed income investments can be compounded over various periods. The most common periodic choices are annual, semi-annual, and continuous. Suppose you have \$100,000 to invest, and banks A , S , and C offer you the same 8% stated interest rate on your money, but A compounds annually, S compounds semiannually, and C compounds continuously. a. Calculate the future value of your money after 5, 10, and 20 years of compound interest at each of the three banks. b. What are the three banks effective annual rates of interest? Which bank gives the best deal (assuming risk is constant among them)? c. Suppose a fourth bank, Bank M , compounds monthly. What stated annual rate does M have to offer you to make you indifferent between investing at Bank M and the best offer you have from the other three banks? Does your answer depend on your time horizon (5, 10, or 20 years)? Solutions:

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This note was uploaded on 04/15/2008 for the course FINA 3313 taught by Professor Yong during the Fall '08 term at UT Arlington.

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problem set 2 solutions - Problem Set#2 Compounding...

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