1. Which of the following assets is worth the most? Which is worth the least?
a) a 25 year, $1,500,000 zero-coupon (no interest) bond
b) a 40 year annuity paying $25,000 per year
c) a new 10 year bond that pays $20,000 per year in interest income plus the return of the principal of $400,000 at maturity
For purposes of this problem, assume that we have determined that an appropriate discount rate to apply for all three instruments is 6%. Assume also that all payments occur at the ends of years involved.
2. Rework problem #1 above, but this time assume a discount rate of 3%. Explain—in plain English, and in language that I can understand—why the numbers (and rankings) changed in the directions they did.