Annuities & Loans practice test

Question: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan).

True
False

Answer: True

Question: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
True
False

Answer: False

Question: Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.

Answer: d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.

Question: Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
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 plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b. The discount rate increases.
c. The riskiness of the investment’s cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e. The discount rate decreases.

Answer: b. The discount rate increases.

Question: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
True
False

Answer: False

Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security’s required return, other things held constant.
True
False

Answer: True

Question: Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.

Answer: c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.

Question: If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.
True
False

Answer: False

Question: Which of the following statements is CORRECT?
a. The New York Stock Exchange is an auction market, and it has a physical location.
b. Home mortgage loans are traded in the money market.
c. If an investor sells shares of stock through a broker, then it would be a primary market transaction.
d. Capital markets deal only with common stocks and other equity securities.
e. While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.

Answer: a

Question: When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage increases in the loan’s later years.
True
False

Answer: True

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.
True
False

Answer: False

Question: Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
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: 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?
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: Which of the following statements is CORRECT?
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: Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
True
False

Answer: True

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.
True
False

Answer: False

Question: Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.
True
False

Answer: True

Question: Which of the following bonds has the greatest price risk?
a. A 10-year $100 annuity.
b. A 10-year, $1,000 face value, zero coupon bond.
c. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
d. All 10-year bonds have the same price risk since they have the same maturity.
e. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

Answer: b

Question: If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.
True
False

Answer: False

Question: If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.
True
False

Answer: True

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.
True
False

Answer: True

Question: Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

Answer Options:
a. True
b. False

Answer: a. True

Annuities & Loans practice test

True False

Question: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).True False

Question: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.True False

Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security’s required return, other things held constant.True False

Question: If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.True False

Question: When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage increases in the loan’s later years.True False

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.True False

Question: Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.True False

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.True False

Question: Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.True False

Question: If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.True False

Question: If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.True False

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.True False

Question: Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

True
False

Question: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
True
False

Question: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
True
False

Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security’s required return, other things held constant.
True
False

Question: If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.
True
False

Question: When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage increases in the loan’s later years.
True
False

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.
True
False

Question: Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
True
False

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.
True
False

Question: Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.
True
False

Question: If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.
True
False

Question: If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.
True
False

Question: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.
True
False