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5. Answer the following questions and provide a brief explanation for each: How would lowering the...

5. Answer the following questions and provide a brief explanation for each:

  1. How would lowering the interest rate affect the future value of a single deposit made today?
  1. How would reducing the frequency of compounding affect the future value of an investment?
  1. How would raising the interest rate affect the present value of a fixed amount of money in the future?
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Homework Answers

Answer #1

a. Future value = Single deposit today * (1 + interest rate)^n

If the interest rate is lowered, the future value would be lowered, all else being equal. The future value and interest rates are directly proportional to each other. Lower intererst rate contributes less to the interest earned and hence lower future value.

b. Reducing the frequency of compounding reduces the future value of the investment because the effective interest rate is lowered with reduced frequency of compounding. So, from a) we know that lowered interest rate lowers the future value.

c. Present value = Fixed amount in the future/(1 + interest rate)^n

The interest rate and present value are inversely proportional to each other. Raising the interest rate lowers the present value of a fixed amount of money in the future, all else being equal.

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