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Eric wants to invest in government securities that promise to pay $1,000 at maturity. The opportunity cost (interest rate) of holding the security is 13.80%. Assuming that both investments have equal risk and Ericâs investment time horizon is flexible, which of the following investment options will exhibit the lower price?

a. An investment that matures in four years
b. An investment that matures in five years

Respuesta :

Answer:

The second option which 5 years to maturity exhibited a lower price of

$523.95  

Explanation:

In order to ascertain the option with lower, it is important we determine the price of each investment based on the fact the price of an investment opportunity today is the present value of its future cash flow is the maturity value of $1000 in both cases:

a.

PV=FV/(1+r)^n

PV=price of investment

FV=future value=$1000

r= 13.80%.

n=4 years

PV=$1000/(1+13.80%)^4

PV=$596.25

b.

PV=FV/(1+r)^n

PV=price of investment

FV=future value=$1000

r= 13.80%.

n=5 years

PV=$1000/(1+13.80%)^5

PV= $523.95  

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