307 Midterm 1

A financial instrument would include: A. only a written obligation and a transfer of value. B. only a written obligation and a specified date. C. a written obligation, a transfer of value, a future date, and certain conditions. D. a written obligation, a transfer of value, a specific date for payment, uncertain conditions.

C

A monthly growth rate of 0.5% is an annual growth rate of: A. 6.00% B. 5.00% C. 6.17% D. 6.50%

C

A promise of a $100 payment to be received one year from today is: A. more valuable than receiving the payment today. B. less valuable than receiving the payment two years from now. C. equally valuable as a payment received today if the interest rate is zero. D. not enough information is provided to answer the question.

C

What is the present value of $100 promised one year from now at 10% annual interest? A. $89.50 B. $90.00 C. $90.91 D. $91.25

C

Which formula below best expresses the expected real interest rate, (r)? A. i = r - πe B. r = i + πe C. r = i - πe D. πe = i + r

C

Compute the present value of a $100 investment made 6 months, 5 years, and 10 years from now at 4 percent interest.

6 months: Present Value = 100/(1.04)0.5 = $98.065 years: Present Value = 100/(1.04)5 = $82.1910 years: Present Value = 100/(1.04)10 = $67.56 Remember, you are calculating the present value of an investment to be made in the future. Notice that the exponent for the 6-months calculation is 0.5, representing one-half of one year into the future.

Juan purchases automobile insurance; the insurance contract is a: A. financial instrument. B. form of money. C. transfer of risk from the insurance company to Juan. D. financial intermediary.

A

Which of the following best expresses the future value of $100 left in a savings account earning 4.5% for three and a half years? A. $100(1.045)3.5 B. $100(0.45)3.5 C. $100 × 3.5 × (1.045) D. $100(1.045)3/2

A

Which of the following statements is most correct? A. We can always compute the ex post real interest rate but not always the ex ante real rate. B. We cannot compute either the ex post or ex ante real interest rates accurately .C. We can accurately compute the ex ante real interest rate but not the ex post real rate. D. None of the statements are correct.

A

Financial instruments used primarily as stores of value include each of the following, except: A. bonds. B. futures contracts. C. stocks. D. home mortgages.

B

Interest rates that are adjusted by subtracting expected inflation are known as: A. coupon rates. B. ex ante (or, expected) real interest rates. C. ex post real interest rates. D. nominal interest rates.

B

Many financial instruments are standardized because: A. it is believed that most parties to a contract do not read them anyway. B. complexity is costly, the more complex a contract, the more it costs to create. C. the standardization of contracts makes them harder to understand. D. it is required by the government.

B

Suppose Tom receives a one-year loan from ABC Bank for $5,000.00. At the end of the year, Tom repays $5,400.00 to ABC Bank. Assuming the simple calculation of interest, the interest rate on Tom's loan was: A. $400 B. 8.00% C. 7.41% D. 20%

B

The primary use of derivative contracts is: A. for IRA and other pension plans since they only have value well into the future. B. to shift risk among investors. C. for investors seeking a greater return by taking greater risk. D. to add to the profits an investor obtains through information asymmetry.

B

The process of financial intermediation: A. creates a net cost to an economy. B. increases the economy's ability to produce. C. is always used when a borrower needs to obtain funds. D. is used primarily in underdeveloped countries.

B

An investment carrying a current cost of $120,000 is going to generate $50,000 of revenue for eachof the next three years. To calculate the internal rate of return we need to: A. calculate the present value of each of the $50,000 payments and multiply these and set this equal to $120,000. B. find the interest rate at which the present value of $150,000 for three years from now equals$120,000. C. find the interest rate at which the sum of the present values of $50,000 for each of the next three years equals $120,000. D. subtract $120,000 from $150,000 and set this difference equal to the interest rate.

C

Tom obtains a car loan from Old Town Bank. A. The car loan is Tom's asset and the bank's liability. B. The car loan is Tom's asset, but the liability belongs to the bank's depositors. C. The car loan is Tom's liability and an asset for Old Town Bank. D. The car loan is Tom's liability and a liability of the bank until Tom pays it off.

C

A lender is promised a $100 payment (including interest) one year from today. If the lender has a 6%opportunity cost of money, he/she should be willing to lend what amount today? A. $100.00 B. $106.20 C. $96.40 D. $94.34

D

The better the information provided to financial markets the: A. less the amount of funds transferred between savers and borrowers. B. greater the amount of funds transferred between savers and borrowers though risk increases. C. higher the return required by lenders. D. greater will be the flow of funds in these markets.

D

Which of the following is not a reason why interbank lending dried up during the financial crisis of2007-2009? A. Banks preferred to hold on to their liquid assets in case their own need for them increased. B. Banks grew increasingly concerned about the ability of their trading partners to repay the loans. C. The increased cost of loans. D. The Fed grew increasingly wary of making liquidity available to banks.

D

Assuming that the current interest rate is 3 percent, compute the present value of a five-year, 5 percent coupon bond with a face value of $1,000. a. What happens when the interest rate goes to 4 percent? b. What happens when the interest rate goes to 2 percent?

Present Value for 5-year 5 percent coupon bond with face value of $1000 (i=3%) =$50/(1.03) + $50/(1.03)2 + $50/(1.03)3 + $50/(1.03)4 + $1050/(1.03)5 = $1091.59 a. Present Value for 5-year 5 percent coupon bond with face value of $1000 (i=4%) =$50/(1.04) + $50/(1.04)2 + $50/(1.04)3 + $50/(1.04)4 + $1050/(1.04)5 = $1044.52The present value falls when the interest rate rises to 4 percent. b. Present Value for 5-year 5 percent coupon bond with face value of $1000 (i=2%) =$50/(1.02) + $50/(1.02)2 + $50/(1.02)3 + $50/(1.02)4 + $1050/(1.02)5 = $1141.40The present value rises when the interest rate falls to 2 percent.

Given a choice of two investments, would you choose one that pays a total return of 30 percent over five years or one that pays 0.5 percent per month for five years?

Second investment

Compute the future value of $100 at an 8 percent interest rate 5, 10, and 15 years into the future. What would the future value be over these time horizons if the interest rate were 5 percent?

Start with 8 percent rates Future value in 5 years = $100x(1.08)5 = $146.93 Future value in 10 years = $100x(1.08)10 = $215.89 Future value in 15 years = $100x(1.08)15 = $317.22 Now consider 5 percent rates: Future value in 5 years = $100x(1.05)5 = $127.63 Future value in 10 years = $100x(1.05)10 = $162.89 Future value in 15 years = $100x(1.05)15 = $207.89

A financial institution offers you a one-year certificate of deposit with an interest rate of 5 percent. You expect the inflation rate to be 3 percent. What is the real return on your deposit?

The real interest rate equals the nominal rate less the expected rate of inflation; therefore 5% - 3% = 2%. This is an approximate formula