Explain why an investor cannot simply compare the size of promised payments from different investments, even if the interest rates and other risk factors are the same.
What will be an ideal response?
The key here is time. Payments that are promised at different times are not equal in value; we could say they are really different units of value. We employ the concept of present value to allow us to make comparisons of promised payments that are due at different time periods. We know that payments that are promised sooner are worth more, other factors held constant (for example interest rates), than payments we have to wait for longer. This is seen from the present value formula. So a saver who is going to make a thorough comparison of different investments must consider the timing of the payments and convert all future payments to present value amounts so they can be compared in the same units.
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a. True b. False
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