Graphic View of the Discounting Process
Explain why this statement is true: “A dollar in hand today is worth
more than a dollar to be received next year.”
What is compounding? What’s the difference between simple inter-
est and compound interest? What would the future value of $100 be
after five years at 10 percent compound interest? At 10 percent simple
interest?
Suppose you currently have $2,000 and plan to purchase a three-
year certificate of deposit (CD) that pays 4 percent interest com-
pounded annually. How much will you have when the CD matures?
What is “discounting,” and how is it related to compounding? How
is the future value equation (2-1) related to the present value equation (2-2)?
How does the present value of a future payment change as the time to receipt is lengthened? As the interest rate increases?
Suppose a U.S. government bond promises to pay $2,249.73 three
years from now. If the going interest rate on three-year government
bonds is 4 percent, how much is the bond worth today? How would your answer change if the bond matured in five rather than three
years? What if the interest rate on the five-year bond were 6 percent rather than 4 percent? ($2,000; $1,849.11; $1,681.13)
How much would $1,000,000 due in 100 years be worth today if the discount rate were 5 percent? If the discount rate were 20 percent?
