1. What is the percentage change in the PV of $100 due in 1 year when the interest rate changes from 5% to 10%? (Move the slider to 10%.) Decreases by 60.6% Decreases by 4.33% Decreases by 4.5% Does not change Increases by 4.5% Increases by 60.6% 2. What is the percentage change in the PV of $100 due in 20 years when the interest rate (cost of capital) changes from 5% to 10%? Decreases by 60% Decreases by 22.83% Does not change Increases by 22.83% Increases by 60.6% 3. The impact of interest rate changes in the PV of $100 due in 20 years compared to the PV of $100 due in one year are: smaller because interest rate changes have a greater impact on the near-term cash flows than distant cash flows. the same because the cash flow is the same. greater because interest rate changes have a greater impact on distant cash flows than near-term cash flows. sometimes less and sometmes more depending on the interest rate.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Exploring Finance: Short-Term versus Long-Term Cash Flows.
Short-Term versus Long-Term Cash Flows
Conceptual Overview: Explore how time and the cost of capital affects the net present values of two alternative investments.
The equations below show the discounted or present value of cash flows either one year or twenty years in the future. The first equation in each set of three shows the discounted value when the interest rate (or cost of capital) equals 5%. The second equation in each set of three shows the discounted value for an interest rate that is controlled by the slider. The third equation compares the two discounted values. Change the slider and observe whether the discounted value of the one-year cash flow changes more or less quickly than the discounted value of the twenty-year cash flow.
1. What is the percentage change in the PV of $100 due in 1 year when the interest rate changes from 5% to 10%? (Move the slider to 10%.)
- Decreases by 60.6%
- Decreases by 4.33%
- Decreases by 4.5%
- Does not change
- Increases by 4.5%
- Increases by 60.6%
2. What is the percentage change in the PV of $100 due in 20 years when the interest rate (cost of capital) changes from 5% to 10%?
- Decreases by 60%
- Decreases by 22.83%
- Does not change
- Increases by 22.83%
- Increases by 60.6%
3. The impact of interest rate changes in the PV of $100 due in 20 years compared to the PV of $100 due in one year are:
- smaller because interest rate changes have a greater impact on the near-term cash flows than distant cash flows.
- the same because the cash flow is the same.
- greater because interest rate changes have a greater impact on distant cash flows than near-term cash flows.
- sometimes less and sometmes more depending on the interest rate.
4. If the interest rate is less than 5%, then the PVs for both the one-year and 20-year investments:
- Decrease because the interest rate is lower.
- Increase because the investments are discounted at a lower rate.
- Do not change becasue the investment amount is the same.
- Might either increase or decrease.
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