Answer Choices:
a. True
b. False
Answer: b. False
Question: Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods.
Answer Choices:
a. True
b. False
Answer: b. 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. 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.
Question: Which of the following bank accounts has the highest 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: e. An account that pays 8% nominal interest with daily (365-day) compounding.
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 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. 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: 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: Starting to invest early for retirement increases the benefits of compound interest.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
Answer Choices:
a. True
b. False
Answer: a. True
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 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. The outstanding balance declines at a faster rate in the later years of the loan’s life.
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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
Answer Choices:
a. True
b. False
Answer: b. False
Question: The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Sue now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
Answer Choices:
a. $205.83
b. $216.67
c. $228.07
Answer: b. $216.67
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.
Answer Choices:
a. True
b. False
Answer: a. True
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: a. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
Question: Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
Answer Choices:
a. True
b. False
Answer: a. True
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 higher.
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. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
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. The cash flows for an annuity due must all occur at the beginning of the periods.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.
b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.
c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.
d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.
Answer: b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.
Question: You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?
Answer Choices:
a. Bank 1; 6.1% with annual compounding.
b. Bank 2; 6.0% with monthly compounding.
c. Bank 3; 6.0% with annual compounding.
d. Bank 4; 6.0% with quarterly compounding.
e. Bank 5; 6.0% with daily (365-day) compounding.
Answer: e. Bank 5; 6.0% with daily (365-day) compounding.
Question: Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.
Answer Choices:
a. True
b. False
Answer: b. False
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. A bank loan’s nominal interest rate will always be equal to or less than its effective annual rate.