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Buy a Note or Money in Bank?

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Suppose someone offered to sell you a note that calls for a $1,000 payment three years from today. The person offers to sell the note for $850. You have $850 in a bank time deposit (savings instrument) that pays a 6.77%APR with daily compounding; and you plan to leave this money in the bank unless you buy the note. The note is not risky—that is, you are sure it will be paid on schedule. Should you buy the note? Check the decision in two ways:

(a) By comparing your future value (FV) if you buy the note versus leaving your money in the bank(FV of the note is $1000, compare this to the FV of leaving $850 in the bank for 3 years with daily interest compounding, should you buy the note?)

(b) By comparing the present value (PV) of the note with your current bank investment (PV of the note is PV of the $1000 payout in 3 years assuming the same daily compounded interest as your bank is paying and the PV of your bank investment is the $850, should you buy the note?)

(c) Based on parts (a) and (b), do you buy the note or keep your money in the bank? Be sure to explain your answer.

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Solution Summary

The solution comprises of formulas and detailed step-by-step calculations for the given problem on future and present values.

Solution provided by:
Anwesha Ghosh, MSc
Education
  • MSc, Osmania University
  • MSc, Indian Institute of Technology - Roorkee (I.I.T.-ROORKEE)
  • BSc, Banaras Hindu University
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