Question

Question #7: Your broker called and offered you the following investment opportunity:

• You will have to invest $1,000 today

• In 7 years the investment will end and you will be paid $1,375

• You will receive no payments until the end of the investment in 7 years

Required: Determine the Implied Interest rate that you will earn on this investment.

Answer 1

Investment, P = $1,000

Duration of investment, n = 7 years

Payment after 7 years, F = $1,375

Let implied rate of interest be i

F = P * (1+i)ⁿ

$1,375 = $1,000 * (1+i)⁷

(1+i)⁷ = $1,375 / $1,000

(1+i)⁷ = 1.375

Seventh Root on both sides

1+i = 1.04654400087

i = 0.04654400087

Implied Interest Rate = 4.654%

Note:

Calculation of Seventh Root of 1.375 using calculator:

Enter 1.375

√ 15 times

- 1

/ 7 (since it is seventh root)

+ 1

* = 15 times

Result = 1.04654400087