Example for Chapter 17

A. If the interest rate is 8%, an asset that pays $100 one year from now, $100, two years from now, and $100 three years from now is worth $____ now so at a price of $280 is _________ (overpriced /underpriced). $100/1.08 = $92.59, $100/(1.08) 2 = $85.73 , $100/(1.08) 3 = $79.38, so the asset is worth $92.59 + $85.73+ $79.38 = $257.70 and it is overpriced at $280.

1. See example A above and answer all three parts (a, b, c)

a. The interest rate is 6%. An asset pays $500 in one year and $500 in year 2. The asset is priced at $950. Is it overpriced or underpriced? Explain.

b. The interest rate is 5%. An asset pays $250 in each of the next four years. The asset is currently worth $_____ and is __________ (overpriced / underpriced) at a price of $900.

c. The interest rate is 10%. An asset pays $1000 one year from now and $2000 two years from now. Theasset is currently worth $_____ and is ________ (overpriced / underpriced) at a price of $2,600.