Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following bank accounts has the lowest effective annual return?
Answer Choices:
a. An account that pays 8% nominal interest with monthly compounding.
b. An account that pays 8% nominal interest with annual compounding.
c. An account that pays 7% nominal interest with daily (365-day) compounding.
d. An account that pays 7% nominal interest with monthly compounding.
e. An account that pays 8% nominal interest with daily (365-day) compounding.
Answer: d. An account that pays 7% nominal interest with monthly compounding.
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. If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.
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. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
Question: A time line is meaningful even if all cash flows do not occur annually.
Answer Choices:
a. True
b. False
Answer: a. True
Question: The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan’s life, the greater the percentage of the payment that will be a repayment of principal.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?
Answer Choices:
a. The monthly payments will decline over time.
b. A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.
c. The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.
d. The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.
e. Exactly 10% of the first monthly payment represents interest.
Answer: b. A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.
Question: Which of the following statements is CORRECT?
Answer Choices:
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 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 can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
Answer: e. Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
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. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.
Question: All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases.
Answer Choices:
a. True
b. False
Answer: b. False
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. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.