Quiz 6: Interest Rate Parity
The value of the prize is being provided and it is mentioned the method of distribution is being provided in order to determine the present value of the prize amount. The amount of prize won is $10,000,000 The amount to be paid per annum is $333,333.33 The number of years is 30 In this case, excel can be used for determining the present value of the prize amount. Below excel discloses the data that are entered for the calculation purposes. Enter in excel B4 "=PV(B1,B2,-B3)" to determine the present value of the prize. Below excel discloses the entered formula. Present value of the prize: The Present value of the prize is $3,752,594.41
Time value of money: The time value of money is the concept states that, the money received today is worth more than the money received in the future. It is also called as present value (PV) of money. In another words, money today has a different value or purchasing power than what it will have in the future. The existence of interest and inflation are the factors which influence the purchasing power of money. This phenomenon is called Time Value of Money. Future value: The future value is the value of cash flow at point of time in future. The compounding technique is used to get the future value. The compound interest is the amount of interest earned on reinvestment of an interest for specific period. When an investor earns interest on investment and reinvests it, then an investor earns interest on principal investment and reinvested interest for specific period. Present value: The present value is the value of future amount at the current time of that time point. The discounting is the technique used in the time value of money to find the present value (PV) of future amount. The PV at time zero on the time line is calculated in the discounting technique. Both the present value and the future value are related to the concept time value of money. If the interest rates are positive, then the amount of future money will not be worth as much as the value of today money. In order to determine what will be the worth of the future money today, then present value of the future money has to be determined. This will be the amount which one person can borrow against future money while making use of the future amount for repaying the principal and interest of the loan. In other words, future value of the amount of the money that is available today is nothing but the value which will be available in future if an investor made investment today and has received principal and interest on investment in future.
5-year interest rate on both the dollar and euro denominated pure discount bonds are provided in order to determine the forward exchange rate in order to eliminate the covered interest rate arbitrage. The forward rate for 5-years can be determined using the given interest rate of U.S. dollar and euro along with the spot exchange rate in order to avoid covered interest rate arbitrage. Following is the formula used to determine the forward exchange rate: Where, On substituting the variables in the above equation: Thus, the forward exchange should be in order to avoid covered interest rate arbitrage.