Question 4-1. You have just taken out a five-year loan from

4-1. You have just taken out a five-year loan from a bank to buy an engagement ring. The ring costs

$5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments

of $1000 at the end of each year. Show the timeline of the loan from your perspective. How would

the timeline differ if you created it from the bank’s perspective?

4-2. You currently have a four-year-old mortgage outstanding on your house. You make monthly

payments of $1500. You have just made a payment. The mortgage has 26 years to go (i.e., it had

an original term of 30 years). Show the timeline from your perspective. How would the timeline

differ if you created it from the bank’s perspective?

4-3. Calculate the future value of $2000 in

a. Five years at an interest rate of 5% per year.

b. Ten years at an interest rate of 5% per year.

c. Five years at an interest rate of 10% per year.

d. Why is the amount of interest earned in part (a) less than half the amount of interest earned

in part (b)?

4-4. What is the present value of $10,000 received

a. Twelve years from today when the interest rate is 4% per year?

b. Twenty years from today when the interest rate is 8% per year?

c. Six years from today when the interest rate is 2% per year?

4-5. Your brother has offered to give you either $5000 today or $10,000 in 10 years. If the interest

rate is 7% per year, which option is preferable?

.

4-6. Consider the following alternatives:

i. $100 received in one year

ii. $200 received in five years

iii. $300 received in ten years

a. Rank the alternatives from most valuable to least valuable if the interest rate is 10% per

year.

b. What is your ranking if the interest rate is only 5% per year?

c. What is your ranking if the interest rate is 20% per year?

4-7. Suppose you invest $1000 in an account paying 8% interest per year.

a. What is the balance in the account after 3 years? How much of this balance corresponds to

“interest on interest”?

b. What is the balance in the account after 25 years? How much of this balance corresponds to

interest on interest?

4-8. Your daughter is currently eight years old. You anticipate that she will be going to college in 10

years. You would like to have $100,000 in a savings account to fund her education at that time. If

the account promises to pay a fixed interest rate of 3% per year, how much money do you need

to put into the account today to ensure that you will have $100,000 in 10 years?

Timeline:

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