Vega research has been conducting investor polls for Third State Bank. They have found the most investors are not willing to tie up their money in a 1-year (2-year) CD unless they receive at least 1.0% (1.5%) more than they would on an ordinary savings account. If the savings account rate is 3%, and the bank wants to raise funds with 2-year CDs, the yield must be at least:
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Since we are taking the view of the minimum amount required to induce investors to lend funds to the bank, this is best described as a required rate of return. Based upon the numerical information, the rate must be 4.5% (= 3.0 + 1.5).
Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside and held for the trip, he should use the 5% as a:
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He needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate.
Wei Zhang has funds on deposit with Iron Range bank. The funds are currently earning 6% interest. If he withdraws $15,000 to purchase an automobile, the 6% interest rate can be best thought of as a(n):
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Since Wei will be foregoing interest on the withdrawn funds, the 6% interest can be best characterized as an opportunity cost — the return he foregoes by postponing his auto purchase until the future.
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