Suppose that a risk-free investment will make three future payments of $500 in 1 year, $500 in 2 years, and $500 in 3 years.Instructions: Round your answers to 2 decimal places.If the Federal Reserve has set the risk-free interest rate at 12 percent, what is the proper current price of this investment?$ What is the price of this investment if the Federal Reserve raises the risk-free interest rate to 14 percent?$

To calculate the present value of future payments, we use the formula for the present value of a future sum, which is:

PV = FV / (1 + r)^n

where:

• PV is the present value
• FV is the future value
• r is the interest rate
• n is the number of periods

1. If the risk-free interest rate is 12 percent (or 0.12), the present value of the investment is calculated as follows:

PV1 = $500 / (1 + 0.12)^1 =$446.43 PV2 = $500 / (1 + 0.12)^2 =$398.62 PV3 = $500 / (1 + 0.12)^3 =$356.16

Adding these up, the proper current price of the investment is $446.43 +$398.62 + $356.16 =$1201.21

2. If the Federal Reserve raises the risk-free interest rate to 14 percent (or 0.14), the present value of the investment is calculated as follows:

PV1 = $500 / (1 + 0.14)^1 =$438.60 PV2 = $500 / (1 + 0.14)^2 =$384.91 PV3 = $500 / (1 + 0.14)^3 =$337.81

Adding these up, the price of the investment if the Federal Reserve raises the risk-free interest rate to 14 percent is $438.60 +$384.91 + $337.81 =$1161.32