ECON 500 University of California Berkeley Cash Flow Money and Banking Worksheet

Answer the questions below. Sumit your answers on iLearn by 10pm on Saturday, July 10th.
Note: Part 1 is worth 15 points – it is on MyEconLab.
1. [5 points] This question relates to Part 1 of chapter 4: Time value of money
a. Why is a dollar received today more valuable than a dollar received in the future? Explain.
b. What is the impact on cash flow if compounding takes place more often (quarterly, or monthly, or daily)?
Explain.
c. What is the effective annual rate? What is the impact on the effective annual rate if compounding over a
one-year period occurs more often? Explain.
2. [2 points] Suppose with an initial investment of $1,000 you can – at a 5% annual interest rate – obtain $1,050 in
one year (no compounding).
How would compounding on a monthly basis alter the future cash flow from the investment? SET UP the
problem (show the equation that is used to obtain the new future cash flow when compounding is taken into
account; substitute in for all values) and discuss (whether the value of the investment is higher or lower than
$1050).
3. [3 points] Consider a fixed payment loan of $45,000 that has 15 years to maturity, with annual FP of $5250,
and i=5%.
a. What is the PV of this loan? SET UP the problem only.
b. What would have been the impact on FP if the borrower had to pay higher interest rates (=6%), yet still
wanted to borrow $45,000 and repay in 15 years? Discuss briefly.
4. [5 points] Consider a 6-years to maturity Coupon bond with Face Value = $1000 and a 5% coupon rate; suppose
it was just now issued.
a. Obtain the PV (i.e. set up the equation and plug in all values).
b. What is the yield to maturity on this bond if the initial buyer of the bond holds this bond for the whole 6
years? Given #. Is there risk associated with holding this bond? Discuss.
c. Suppose that interest rates rise over time. What will be the impact on prices of bonds over time? Why?