Question

If you are offered a one-year bond that guarantees to pay a 10% return, then what would be the minimum payout after one year you would need to be offered in order to make it worthwhile for you to invest $10,000 into a competitive investment of equal risk?

Answer 1

The minimum payout after one year needed to make it worthwhile to invest $10,000 into a competitive investment with equal risk is $8,917.39

Step-by-step explanation:

In this scenario, the bond is offering a guaranteed 10% return. However, the market interest rate is now 12%, which means you could invest $964 in an alternative investment and receive $1,080 after one year. To make it worthwhile for you to invest $10,000 into a competitive investment of equal risk, the minimum payout after one year would need to be at least $8,917.39.

To calculate this minimum payout, you can use the formula:

Minimum Payout = Investment Amount / (1 + Market Interest Rate)

Substituting the values, we get:

Minimum Payout = $10,000 / (1 + 0.12) = $8,917.39

Answer 2

10% of the investment = $1,000

Step-by-step explanation:

The bond guarantees a 10% rate of return and you have $10,000 to invest.

The other investment offers similar risk, so you should demand at least the same rate of return = 10% or $1,000

Investors are risk averse, and the higher the risk, the larger the return expected form an investment. If you have two investments with the same level of risk, you should be able to demand the same return from both investments. If the risk of one investment is higher, then you should demand a higher return from than investment. On the other hand if the investment has a lower risk, you should demand a lower rate of return.