Question

I have a deal for you! You can have EITHER $1,000 or $1,050 one year from today. Which deal would you chose and Why?

Answer 1

i=(FV/PV)^(1/n) -1

i=interest rate

FV=future value

PV=present value

n=years

i=(1050/1000)^(1/1) -1

i=0.05=5%

The amount today is 5% less than the amount in the future. You will accept $1000 if the market interest rate is less than 5% and you will accept $1050 if the market interest rate is greater than 5% and you will be neutral between both options if the market interest rate is 5%.

Because if the market interest rate is less than 5%, then you are getting more in the future. If the market interest rate is above 5%, you are getting less in the future, and if the market interest rate is 5%, you will get the same amount in both periods.