Assume a bank loan requires an interest payment of $85 per year and a principal

Question

Assume a bank loan requires an interest payment of $85 per year and a principal payment of $1,000 at the end of the loan's eight-year life.

a. At what amount could this loan be sold for to another bank if loans of similar quality carried an 8.5 percent interest rate? That is, what would be the present value (PV) of this loan?

b. Now, if interest rates on other similar quality loans are 10 percent, what would be the PV of this loan?

c. What would be the PV of the loan if the interest rate is 8 percent on similar quality loans?

Explanation / Answer

P = [ ( C/r) * (1-1/(1+r)^n ) ] + Principal/(1+r)^n

a) C = $85 , r = 0.085 , Principal = $1000 , n = 8

substituting values , we get P = $1000

b) If r =0.1 all else being same P = $919.98

c) If r =0.08 all else being same P = $1028.733

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