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Textbook Question
Chapter 5, Problem 1P

Your bank is offering you an account that will pay 20% interest in total for a two-year deposit. Determine the equivalent discount rate for a period length of

  1. a. Six months.
  2. b. One year.
  3. c. One month.

a)

Expert Solution
Check Mark
Summary Introduction

To determine:

The equivalent discount rate for six months.

Introduction:

The discount rate is the interest rate that is charged to depository institutions and commercial banks for the loan received. The discount rate is used to calculate the present value of future cash flows.

Answer to Problem 1P

The equivalent discount rate for six months is 4.66%.

Explanation of Solution

Given information:

A bank offers Person X an account that pays 20% interest rate in total for a two-year deposit.

Formula to compute the equivalent discount rate:

Equivalent discount rate = (1+r)n1

Here

r = rate of interest.

n = number of years.

Equivalent discount rate = (1+r)n1=(1+0.2)141=1.04661=0.0466

Hence, the equivalent discount rate for six months is 0.0466 or 4.66%.

b)

Expert Solution
Check Mark
Summary Introduction

To determine:

The equivalent discount rate for one year.

Answer to Problem 1P

The equivalent rate for one year is 9.54%.

Explanation of Solution

Given information:

A bank offers Person X an account that pays 20% interest rate in total for a two-year deposit.

Formula to compute the equivalent discount rate:

Equivalent discount rate = (1+r)n1

Here

r = rate of interest.

n = number of years.

Equivalent discount rate = (1+r)n1=(1+0.2)121=1.09541=0.0954

Hence, the equivalent discount rate for one year is 0.0954 or 9.54%.

c)

Expert Solution
Check Mark
Summary Introduction

To determine:

The equivalent discount rate for one month.

Answer to Problem 1P

The equivalent discount rate for one month is 0.761%.

Explanation of Solution

Given information:

A bank offers Person X an account that pays 20% interest rate in total for a two-year deposit.

Formula to compute the equivalent discount rate:

Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series), Chapter 5, Problem 1P Equivalent discount rate = (1+r)n1

Here

r = rate of interest.

n = number of years.

Equivalent discount rate = (1+r)n1=(1+0.2)1241=1.007611=0.00761

Hence, the equivalent discount rate for one month is 0.00761 or 0.761%.

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Chapter 5 Solutions

Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)

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