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Does the Pot of Money Have to be in the Future?

Does the Pot of Money Have to be in the Future?. No The U.S. Savings Bond Game Many groups like to give savings bonds as prizes Why - Because a savings bond is worth its face amount in the future It cost less than that today Lets you give bigger prizes without coming up with the cash.

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Does the Pot of Money Have to be in the Future?

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  1. Does the Pot of Money Have to be in the Future? • No • The U.S. Savings Bond Game • Many groups like to give savings bonds as prizes • Why - • Because a savings bond is worth its face amount in the future • It cost less than that today • Lets you give bigger prizes without coming up with the cash

  2. Example • The Department of Art at SIU is sponsoring a contest for High School Students. Teams will compete in making the most inspiring statue of a Saluki Dog out of beer cans (which the sponsors emptied first), toilet paper (which everyone gets fresh), and used chewing gum (the teams get to convert fresh gum to used). First prize is a $100 savings bond that matures in 5 years. The Government will pay 5.5% interest (compounded annually) on the bond. What will the Department of Art pay for the bond?

  3. Step #1 • We need to decide what perspective we will look at the cash flow from (we have the Government that will issue the bond, and the buyer). • I’m going to choose the buyer because the problem is about the Department of Art that will buy the bond

  4. Setting Up My Cash Flow What I need to do is sweep this $100 dollars back into the here and now pot to find out how much its worth. $100 0 1 2 3 4 5

  5. Enter Our Magic Number Oh ________ F/P sweeps a present number into the future pot. F/P Rules I want to sweep Future dollars into the right now pot.

  6. Now What Do I Do? • F/P * Present = Future • How about • P/F * Future = Present

  7. Creating a New Magic Number • To do it with the symbol all I had to do was flip it over • Turns out the same thing works with the formula • F/P Flips to P/F • (1 + i )n Flips to 1/( 1 + i )n or (1 + i )-n

  8. Working Our New Hero • We want to sweep $100 back • 5 compounding periods at • 5.5% • (1 + 0.055)-5 = 0.76513 0 1 2 3 4 The Bond will cost $76.51

  9. This Same Thinking Drives the Bond Market Companies issue bonds worth some amount at maturity. 0 1 2 3 4 The bond markets evaluate what Rate of Return is needed considering inflation, safe return, the risk of the company issuing the bond and then considering when the bond matures they use a P/F factor to see what its worth today.

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