Consider two assets with the following cash flow streams:

Asset A generates $4 at t=1, $3 at t=2, and $10 at t=3. Asset B generates $2 at t=1, $X at t=2, and $10 at t=3.

Suppose X=6 and the interest rate r is constant.

(a) For r=0.1, calculate the present value of the two assets.

(b) Determine the set of all interest rates {r} such that asset A is more valuable than asset B.

(c) Draw the present value of the assets as a function of the interest rate.

(d) (i) Suppose r=0.2. Find the value X such that the present value of asset B is 4.

(ii) Suppose the (one-period) interest rates are variable and given as follows: r01=0.1, r12=0.2, r23=0.3. Calculate the yield to maturity of asset A. (You can use Excel or a scientific calculator to find the solution numerically.)

Answer rating: 100% (QA)

PV of Asset A cashflows Year 1 2 3 Cashflows 4 3 10 PV factor 10 0909 0826 0751 11interest ratenth y... View the full answer