Question

Suppose that a risk-free investment will make three future payments of $500 in one year, $500 in two years, and $500 in three years. Instructions: Round your answers to 2 decimal places. a. If the Federal Reserve has set the risk-free interest rate at 16 percent, what is the proper current price of this investment

Answer 1

$1,123

Step-by-step explanation:

Data provided

Interest rate = 16%

Number of Years = 3

Future payments for one year, two year and three year = $500

The computation of proper current price of the investment is given below:-

Current price = $500 × PVIFA (16%, 3)

= $500 × 2.246

= $1,123

Here, we refer the PVIFA table.

Second method

= ($500 ÷ 1.16)^1 + ($500 ÷ 1.16)^2 + ($500 ÷ 1.16)^3

= $431.0344828 + $371.5814507 + $320.3288368

= 1122.94477

or

= $1,123

So, for computing the proper current price of the investment we simply applied the above formula.