Assume that you inherited some money. A friend of yours is working as an unpaid
ID: 2696947 • Letter: A
Question
Assume that you inherited some money. A friend of yours is working as an unpaid intern at a local brokerage firm, and her boss is selling securities that call for 4 payments of $50 (1 payment at the end of each of the next 4 years) plus an extra payment of $1,000 at the end of Year 4. Your friend says she can get you some of these securities at a cost of $850 each. Your money is now invested in a bank that pays an 10% nominal (quoted) interest rate but with quarterly compounding. You regard the securities as being just as safe, and as liquid, as your bank deposit, so your required effective annual rate of return on the securities is the same as that on your bank deposit. You must calculate the value of the securities to decide whether they are a good investment. What is their present value to you? Round your answer to the nearest cent.
$
Explanation / Answer
The effective interest rate of bank deposit is 1.025^4 - 1 = .10381289 = 10.381289%
The value of the security is 50/1.1038 + 50/1.1038^2 + 50/1.1038^3 + 50/1.038^4 + 1000/1.038^4 = 830.8188 = 830.82
Hence the value of the security is 830.82 and hence 850 is a higher price and thus not a good investment