Answer Choices:
a. True
b. False
Answer: a. True
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. 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. 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. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.
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).
Answer Choices:
a. True
b. False
Answer: a. True
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.
Answer Choices:
a. True
b. False
Answer: b. False
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 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: Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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 Choices:
a. True
b. False
Answer: b. False
Question: When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment’s percentage declines in the loan’s later years.
Answer Choices:
a. True
b. False
Answer: b. 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.
Answer Choices:
a. True
b. False
Answer: b. False
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?
Answer Choices:
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: 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. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.
Question: All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.
Answer Choices:
a. True
b. False
Answer: a. True
Question: The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transaction 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. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.
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 increase over time.
b. A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.
c. The total dollar amount of interest being paid off each month gets larger 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 larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.