1. Your classmate asks you for a loan of $10.00.00 today in exchange for promising you a repayment of

$12.00 in one week. You agree to make the loan, knowing that he always carries out his promises.

Market interest rates have suddenly changed. Prior to your lending ten dollars to him, your same classmate decides that he doesn’t want to repay you the principal and interest (face value F1 of his bond) in one week, but would prefer to spread the total repayment out over two weeks. He offers you an opportunity to lend him some dollars today, but in return he will repay you something one week from today and the rest exactly two weeks from today. After some hard-fought negotiations, you reach an agreement with him to repay you $1.00 one week from today and $11.45 two weeks from today but both you and he need to determine the market price (principal) Bo of the bond (loan) today before he's willing to borrow from you.

a. If you agree to loan him $9.00 today, is there a single "interest rate" for this loan? If so, what is it?

b. Now both you and he observe that one dollar today will buy a riskless one week loan with a face value F1 of $1.01 or a two week loan with a face value of F2= $1.04. For the repayments he's offered you, what amount would you loan him today for the bond (loan) he wants?

Answer rating: 100% (QA)

a Yes there is a single interest rate for this loan We can calculate it using the for... View the full answer