Question: Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
Answer Choices:
a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
c. A bank loan’s nominal interest rate will always be equal to or less than its effective annual rate.
d. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
Answer: c
Question: Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
Answer Choices:
a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
c. A bank loan’s nominal interest rate will always be equal to or greater than its effective annual rate.
d. If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.
e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
Answer: d
Question: Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
Answer Choices:
a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.
b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.
c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.
d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
e. The outstanding balance declines at a slower rate in the later years of the loan’s life.
Answer: b
Question: Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
Answer Choices:
a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.
b. Because the outstanding balance declines over time, the monthly payments will also decline over time.
c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.
d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
e. The outstanding balance declines at a faster rate in the later years of the loan’s life.
Answer: e
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.
b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.
c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.
d. If you solve for I and get a negative number, then you must have made a mistake.
e. If CF0 is positive and all the other CFs are negative, then you cannot solve for I.
Answer: c
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.
Answer Choices:
a. True
b. False
Answer: False
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant.
Answer Choices:
a. True
b. False
Answer: False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
c. The cash flows for an annuity due must all occur at the ends of the periods.
d. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.
e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
Answer: d
Question: A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?
Answer Choices:
a. The periodic interest rate is greater than 3%.
b. The periodic rate is less than 3%.
c. The present value would be greater if the lump sum were discounted back for more periods.
d. The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.
e. The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.
Answer: e
Question: Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
Answer Choices:
a. The periodic rate of interest is 2% and the effective rate of interest is 4%.
b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.
c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%.
d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.
e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.
Answer: d
Question: Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
Answer Choices:
a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%.
b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%.
c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.
d. The periodic rate of interest is 3% and the effective rate of interest is 6%.
e. The periodic rate of interest is 6% and the effective rate of interest is also 6%.
Answer: c
Question: You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?
Answer Choices:
a. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
d. The present value of DUE exceeds the present value of ORD, while the future value of DUE exceeds the future value of ORD.
e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.
Answer: a
Question: You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?
Answer Choices:
a. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE.
b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
d. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.
e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.
Answer: d
Question: A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
Answer Choices:
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
d. The last payment would have a higher proportion of interest than the first payment.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
Answer: c
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.
b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.
c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the FV of the negative CFs. It is impossible to find the value of I without a computer or financial calculator.
d. If you solve for I and get a negative number, then you must have made a mistake.
e. If CF0 is positive and all the other CFs are negative, then you can still solve for I.
Answer: e
Question: A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
Answer Choices:
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.
d. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
Answer: d
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
c. The cash flows for an annuity due must all occur at the beginning of the periods.
d. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.
e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
Answer: c