The US government wants to sell a bond worth 1 million dolla

The U.S. government wants to sell a bond worth $1 million dollars to the highest bidder. That is, it wants to borrow as much as it can and promises to pay $1 million in exactly five years. What is the maximum price you would be willing to pay for this bond if you think the interest rate should be

a) 3 percent?

b) 8 percent?

c) 12 percent?

Solution

We need to calculate the Present worth of investment for each given interest rate value

When r=3%

We are going to realise $1 mn of cash receipts after 5 year in lmpsum value then Present Worth would be

$1mn/(1.03)^5=$862608.78

This is the Maximum Price we can pay for Bond when r=3% if i pay more than that then i would earn less than 3% o on this bond

b)

r=8%

SImilar method then PW =$1mn/(1.08)^5=$680583.19

c)

r=12%

PW=$1mn/(1.12)^5=$567426.86

Therefore Maximum Willing to pay price for 3%,8% and 12% is $862608.78, $680583.19 & $ 567426.86 respectively