Explaining and Pricing Basic Financial Instruments
local business you have both known for many years. The business is doing well,
and looks very likely to pay back the loan. Your friend now needs to raise some
cash urgently for other business investments, and wishes to sell her loan on to
someone. Interest rates are 5% and she lent them $2,000 for 2 years at 5%
exactly a year ago. The borrower paid last year’s interest ($100) this morning,
but is not due to pay anything more until a year from today, when they will pay
$100 interest & $2,000 capital. What is the most money your friend could
get for her loan note?
2) Now suppose that your friend had lent the money several
years ago, when interest rates were higher, she lent them $2,000 at 10%. But
interest rates are now 5%. One year from now your friend will receive $200
interest & $2,000 of capital. What is the most her loan is worth today?
3) Interest rates are 5% a year, and one share in a gas
company called warmth pays a dividend of $2 today. The market believes that
warmth will grow profits & dividends by 3% a year from next year forever.
What is a share worth today?
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