Time Value of Money
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Apply the concept of present value to Second Life. Suppose Second Life is selling a bond that will pay you $1000 in one year from today. Keep in mind that if Seconbd Life has financial difficulties in one year you might not get your full $1000 back. Given that a dollar one year from now is always worth less than a dollar today, you most certainly would not pay a full $1000 for this bond. Given the concepts of the time value of money, answer the following questions:
1. How much would you pay for this bond today? Take into consideration your own personal risk preferences, interest rates, inflation, and the probability your company will not be able to pay you back in one year.
2. Based on your answer to the previous question, what would be your discount rate for this bond? Use the present value formulas from the background materials and show your work.
3. Pick two other companies in the same industry as your SLP company. One should be one that you would pay less for a $1000 bond than you would from your SLP company and another one that you would pay more for a $1000 bond from your SLP company. Explain why you would pay more or less for their bonds.
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1. There are a lot of factors that I have to consider while pricing the present value of this bond. Some of these are as follows:
a. I can easily earn approximately 5% to 6% in a risk free CD by investing money in that for a year. Thus, I would not pay more than $950.
b. On top of it, this is definitely riskier than a CD as there is a likelihood that I may not get anything. I imagine that the probability of me not getting anything is remote (around 10%). So the expected value is already close to $900 (with a 10% ...
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