Question

a. You are considering an investment of $55,000 in an account that pays 8.3 percent compound interest. How much less interest would you earn in a 3-year period if the interest was simple?

(10%) b. Your firm wants to borrow $250.000 for 10 years from the bank in order to pursue a big

investment opportunity. The bank will lend the money but it requires an upfront fee of $ 10,000. The interest is 6.3%. How much will you be paying per year for this loan? (20%)

c. You are considering 30 year fixed rate mortgage to buy a new home for $200,000. The bank offers an 3.3% APR for this loan. You can only afford monthly payments of $400, so as a solution you offer to pay off any remaining loan balance at the end of the loan in the form of balloon payment. How large should this balloon payment ? In which case in the real world would a balloon payment make sense? (20%)

Answer 1

a. Interest Earned under Compound Interest = Principal * (1 + r)^N - Principal

Interest Earned under Compound Interest = 55000 * ((1.083^3) - 1)

Interest Earned under Compound Interest = $14863.13

Interest Earned under Simple Interest = Principal * Rate * Years / 100 = 55000 * 3 * 8.30% / 100 = $13695

Less interest would you earn in a 3-year period if the interest was simple = $14863.13 - 13695 = $1168.13

b. Yearly payment

c. PV of Payments = PV(0.033/12,360,-400)" = $91333.54

Principal yet to be paid in present value terms = $200000 - 91333.54 = $108666.64

balloon payment = 108666.64*(1+(0.033/12))^360 = $292049.83

Loan taken in purchase of car or in purchase house are probably result in Balloon Payment