Use the following information to answer the question(s)below:
Suppose the term structure of risk-free interest rates is given as:
Term 1 year 2 years 3 years 5 years 10 years
Rate 2.25% 2.80% 3.20% 4.10% 6.30%
-The present value of an investment that pays $2000 in one year and $3000 in three years for certain is closest to:
A)$4707.
B)$4685.
C)$4729.
D)$5000.

Question

Quizplus · Accepted Answer

The present value of a cash flow at time t in the future is given by:
PV = (Cash Flow at time t) / (1 + r)t
where r is the risk-free interest rate for a term equal to t. Using this formula for the given cash flows and interest rates, we get:
PV of $2000 in one year = 2000 / (1 + 0.0225)1 = $1958.94
PV of $3000 in three years = 3000 / (1 + 0.032)3 = $2592.39
Total PV = 1958.94 + 2592.39 = $4551.33. 
Therefore, the best answer choice is B) $4685, as it is closest to the calculated value of $4551.33.

Use the Following Information to Answer the Question(s)below