# Principles of Finance

 QUESTION 1: Compute the future value for the following: a \$2,000 after being invested for two years in a savings account with 3% interest rate FUTURE VALUE = b. \$5,000 after being invested for ten years in a savings account with a 1% interest rate FUTURE VALUE = c. \$3,500 after being invested for nine years in a savings account with an 11% interest rate FUTURE VALUE = QUESTION 2: Compute the present value for the following: a. \$3,000 to be paid in one year with a 9% discount rate PRESENT VALUE = b. \$3,000 to be paid in three years with a 9% discount rate PRESENT VALUE = c. \$4,000 to be paid in ten years with a 5% discount rate PRESENT VALUE =

NOTE: YOU CAN EITHER USE THE EXCEL FORMULA FOR FUTURE VALUE OR CALCULATE BY HAND USING THE FUTURE VALUE FORMULA. THE TAB LABELED “Help for Future Value” IN THIS WORKBOOK WALKS YOU THROUGH USING THE EXCEL FORMULA. IF YOU PREFER TO CALCULATE BY HAND USING THE FUTURE VALUE FORMULA, IT IS: FV = PV(1+r)t

NOTE: YOU CAN EITHER USE THE EXCEL FORMULA FOR PRESENT VALUE OR CALCULATE BY HAND USING THE PRESENT VALUE FORMULA. THE TAB LABELED “Help for Present Value” IN THIS WORKBOOK WALKS YOU THROUGH USING THE EXCEL FORMULA. IF YOU PREFER TO CALCULATE BY HAND USING THE PRESENT VALUE FORMULA, IT IS: PV = FV/(1+r)t

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## Questions 3 – 5

 QUESTION 3: Compute the present value for the following: a. An investment that will pay you \$1,000 in one year, another \$1,000 in two years, and a third payment of \$1,000 in three years (e.g., three payments of \$1,000 to be paid once a year for three years). The discount rate is 4%. PRESENT VALUE = b. The same three \$1,000 payments as in part a) above, but with a 6% discount rate PRESENT VALUE = c. An investment that will pay you \$2,000 in one year, another \$1,500 in two years, and a third payment of \$3,000 in three years. The discount rate is 4%. PRESENT VALUE = QUESTION 4: Compute the value of the following bonds assuming a 3% discount rate (required rate of return) a. A zero-coupon bond that pays \$1,000 in five years (Hint: PMT = 0) BOND PRICE (PRESENT VALUE) = b. A bond that pays \$1,000 in five years, with five annual coupon payments of \$20 each BOND PRICE (PRESENT VALUE) = c. What is the coupon rate if coupon payments are \$20 per year? At what discount rate would the value of the bond be “at par” (e.g., be worth \$1,000?). Explain your reasoning. COUPON RATE = DISCOUNT RATE IF VALUE AT PAR = EXPLAIN ANSWER FOR DISCOUNT RATE ABOVE = QUESTION 5: This part of the assignment is purely conceptual with no computations required. Explain the following with references to the required readings: What is likely to happen to interest rates if the rate of inflation suddenly increases? ANSWER: Suppose there are two bonds each with coupon payments of \$50. The first bond pays \$1,000 in five years, and the other one pays \$1,000 in ten years. If interest rates increased, would the value of the bonds increase or decrease? ANSWER: Which of the two bonds would have their value change more after the increase in interest rates? ANSWER: Explain your reasoning to your answer above. ANSWER:

NOTE: YOU CAN EITHER USE THE EXCEL FORMULA FOR NET PRESENT VALUE OR CALCULATE BY HAND USING THE PRESENT VALUE FORMULA. THE TAB LABELED “Help for Multiple Cash Flows Q3” IN THIS WORKBOOK WALKS YOU THROUGH USING THE EXCEL FORMULA. IF YOU PREFER TO CALCULATE BY HAND USING THE PRESENT VALUE FORMULA, IT IS: PV = FV/(1+r)t

NOTE: BOND PRICE CAN BE FOUND BY USING THE PRESENT VALUE FORMULA. YOU CAN EITHER USE THE EXCEL FORMULA FOR PRESENT VALUE OR CALCULATE BY HAND USING THE PRESENT VALUE FORMULA FOR EACH CASH FLOW. IF USING THE EXCEL FORMULA: RATE = DISCOUNT RATE NPER = NUMBER OF TIMES PERIODS UNTIL THE BOND MATURES PMT = COUPON PAYMENT FV = FACE VALUE

INCREASE

DECREASE

STAY THE SAME

THE VALUE OF THE FIRST BOND PAYING \$1,000 IN FIVE YEARS WOULD CHANGE MORE

THE VALUE OF THE SECOND BOND PAYING \$1,000 IN TEN YEARS WOULD CHANGE MORE

THE VALUES OF THE BONDS WOULD NOT CHANGE

THE VALUES OF THE BONDS WOULD CHANGE BY THE SAME AMOUNT

## Help for Future Value Q1

 TO COMPUTE FUTURE VALUE IN EXCEL: STEP 1: INSERT THE FUTURE VALUE (FV) FORMULA. CHOOSE THE FORMULAS TAB – FINANCIAL – FV (SEE BELOW). YOU CAN ALSO INSERT THE FORMULA BY TYPING =FV IN ANY CELL. STEP 2: FILL OUT EACH OF THE FIELDS IN THE FUTURE VALUE WINDOW RATE = INTEREST RATE, ENTERED AS A PERCENT OR DECIMAL NPER = NUMBER OF TIME PERIODS THE INVESTMENT WILL ACCRUE INTEREST PMT = 0 UNLESS PAYMENTS ARE MADE PV = THIS IS THE PRESENT VALUE OF THE INVESTMENT; IF YOU ARE PUTTING MONEY INTO AN ACCOUNT, YOU WILL NEED TO INCLUDE A NEGATIVE (-) BEFORE IT TO INDICATE THE MONEY IS LEAVING YOUR POCKET AND GOING INTO AN ACCOUNT TYPE = LEAVE AS 0, WHICH INDICATES INTEREST IS PAID AT THE END OF EACH TIME PERIOD FOR THE SAMPLE WINDOW BELOW, \$2,000 WAS PUT INTO AN ACCOUNT THAT EARNED 3% INTEREST FOR 1 YEAR. AT THE END OF THAT ONE YEAR, THE ACCOUNT BALANCE WAS \$2,060. YOU COULD ALSO USE THE FUTURE VALUE FORMULA AND HAND CALCULATE: FV = PV(1+r)t FV = 2000(1+.03)1 FV = 2060

## Help for Present Value Q2

 TO COMPUTE PRESENT VALUE IN EXCEL: STEP 1: INSERT THE PRESENT VALUE (PV) FORMULA. CHOOSE THE FORMULAS TAB – FINANCIAL – PV (SEE BELOW). YOU CAN ALSO INSERT THE FORMULA BY TYPING =PV IN ANY CELL. STEP 2: FILL OUT EACH OF THE FIELDS IN THE PRESENT VALUE WINDOW RATE = INTEREST RATE, ENTERED AS A PERCENT OR DECIMAL NPER = NUMBER OF TIME PERIODS THE INVESTMENT WILL ACCRUE INTEREST PMT = 0 UNLESS PAYMENTS ARE MADE FV = THIS IS THE FUTURE VALUE OF THE INVESTMENT TYPE = LEAVE AS 0, WHICH INDICATES INTEREST IS PAID AT THE END OF EACH TIME PERIOD FOR THE SAMPLE WINDOW BELOW, AN INVESTOR WANTS TO WITHDRAW \$3,000 IN 2 YEARS. THE INVESTMENT WILL EARN 9% INTEREST. HOW MUCH WOULD NEED TO BE INVESTED TODAY? THE INVESTOR WOULD NEED TO PUT \$2,525.04 INTO AN ACCOUNT. YOU COULD ALSO USE THE PRESENT VALUE FORMULA AND HAND CALCULATE: PV = FV/(1+r)t PV = 3000/(1+.09)2 PV = 2525.04