Share
Explore BrainMass

Time Value of Money Chart

This problem involves a contract where someone receives money every few months for a certain length of time and then wants to sell the contract for an arbitrage oppurtunity.

Anyone can buy or sell a contract that entitles the owner (buyer) to receive $80.00 every six months for the next two years (payments made at the end of each period). When the buyer receives the final $80.00 payment, she or he will receive an addition $1,000. The cash flow is shown in the table below.

Today 6 months 12 months 18 months 24 months
$80.00 $80.00 $80.00 $80.00 + $1,000

The rate of return you require to invest in such a project is an 8.0 APR compounded semi-annually. It's 8.0% since there is an alternative investment account available to you which pays an 8.0 APR compounded semi-annually. The price of the contract is $1,200.
a. In the table below, you can report future withdrawals, interests-rate payments, and ending balances for each period following a deposit made, today, into your alternative investment account. Use this table to show me how you could earn an arbitrate profit by selling the contract.

Today 6 months 12 months 18 months 24 months
Deposit
Interest payment
withdrawal amount (This is the amount required to pay the buyer of the contract)
ending balance for period

b. What is the no-arbitrage price of the contract described above (i.e., what is the fair value of the contract?)

c. Prove this by using the same accounting table below, that your answer to part b is indeed the fair value of the contract (i.e., you would only break even if you sold the contract).

Today 6 months 12 months 18 months 24 months
Deposit
Interest payment
withdrawal amount (This is the amount required to pay the buyer of the contract)
ending balance for period

Attachments

Solution Preview

The completed file is attached. We have calculated interest at 8% p.a. and filled the table. In the first case the deposit gives a ...

Solution Summary

The solution has a time value of money problem relating to amounts deposited and withdrawn for various durations.

$2.19