Question

You are at a dinner party and you run into a friend from your college days at ASU who is an attorney now. Your friend tells you that she is close to settling the biggest case of her career thus far. Her client became disabled as a result of a store slip and fall accident. It is estimated that her client will lose $175,000 annually in employment and benefits for the next 10 years as a result of the disability. You are curious about how the settlement amount is determined. Your client tells you that she discounts the lost future income at a risk-free Treasury rate. You believe that the Federal Reserve is going to target an increase in interest rates which will increase the risk-free Treasury rate.

What impact will an increase in the risk-free rate have on the settlement value?

a. The settlement value will go up.

b. The settlement value will go down.

Answer 1

Increase in risk free rate will be leading to lower the overall value of the settlement value because when we are calculating the settlement value at the present, then if the discount rate is increased, it will lead to lower present value and hence the overall settlement value will decrease.

In this case,risk free rate is treated as the discount rate and when the discount rate will be increasing the overall present value or settlement value will be lower.

Hence the correct answer will be option (B) The settlement value will go down.