Would you rather have $100 today or $105 in one year? What does your answer depend on? What happens to your choice as the interest rate rises? As the interest rate falls?
a) Our answer would depend upon the current market interest rates.
Rate at which I will be indifferent between both the choices will make the PV of future $105 equal to current $ 100.
i.e. 105/((1+i)^1) = 100, solving for i =5%
So, if currently the market interest rate is :
b) If the interest rates rises, the present value of any future amount decreases. Thus, PV of $105 would be lower than $100 if interes rate increases over 5%
c) If the interest rates falls, the present value of any future amount increases. Thus, PV of $105 would be higher than $100 if interes rate falls below 5%.
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