FIN Exam2

The time value of money is based on the belief that a dollar that will be received at some future date is worth more than a dollar today. T/F

False

The value of an asset depends on the historical cash flows up to the present time. T/F

False

The annual percentage rate (APR) is the nominal rate of interest found by multiplying the periodic rate by the number of periods in one year. T/F

True

The annual percentage yield (APY) is the effective rate of interest that must be disclosed to customers by banks on their savings products as a result of "truth in savings laws." T/F

True

The coupon rate on a bond represents the percentage of the bond's par value that will be paid annually, typically in two equal semiannual payments, as interest. T/F

True

The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity for interest rate greater than zero. T/F

True

The yield to maturity on a bond with price equal to its par value will ________. -be less than the coupon rate -always be equal to the coupon rate -be less than or equal to the coupon rate depending on the required return -be more than the coupon rate

always be equal to the coupon rate

A bond rate Aaa according to Moody's, is considered _______. -a medium grade bond -a high grade bond -an upper medium grade bond -an investment grade bond

an investment grade bond

A debenture is _______. -a secured bond that is secured by unspecified assets -an unsecured bond that only creditworthy firms can issue -a bond secured by specific assets that any firm can issue -a secured bond issues by startup firms

an unsecured bond that only creditworthy firms can issue

The _____ feature permits the issuer to repurchase bonds at a stated price prior to maturity. -call -swap -put -conversion

call

A bond that is issued by a foreign corporation or government and is denominated in the investor's home currency and sold in the investor's home market.

Foreign bond

An upward-sloping yield curve indicates that long-term interest rates are generally higher than short-term interest rates.

Normal yield curve

The cash flows occur at the end of each period.

Ordinary Annuity

The rate of interest actually paid or earned, also called the annual percentage rate (APR), is the ______ interest rate. -nominal -effective -continuous -discounted

effective

The _____ rate of interest is the rate that balances the supply of savings and the demand for investment funds. -real -equilibrium -risk-free -nominal

equilibrium

Which of the following explains the general shape of the yield curve? -securities market theory -capital asset pricing theory -perfect market theory -expectations theory

expectations theory

expected returns

focus of the forward looking approach

Actual returns

historical data to measure

Payment of interest required only when earnings are made available from which to make a payment is characteristic of a ________. -income bond -floating rate bond -mortgage bond -equipment trust certificate

income bond

The future value of a dollar _______ as the interest rate increases and _______. -increases; decreases -increases; increases -decreases; increases -decreases; decreases

increases; decreases

The future value of a dollar _______ as the interest rate increases and __________ the longer the money remains invested. -decreases; increases -increases; increases -decreases; decreases -increases; decreases

increases; increases

The main idea behind the time value of money is that a dollar today is worth more than a dollar in the future because _______ -inflation erodes the value of money over time -investors can earn a return on money they have today and thereby have more money in the future -investors are impatient -the future is more uncertain than the present

investors can earn a return on money they have today and thereby have more money in the future

What is the rate of return on an investment of $20,130 if the company expects to receive $3,000 at the end of each year for the next 10 years? -3% -18% -8% -13%

irr(rate of return) = 8%

An annuity with an infinite life is called a(n) ______. -primia -deep discount -option -perpetuity

perpetuity

The amount of money that would have to be invested today at a given interest rate over s specified period in order to equal a future amount is called _______. -future value of an annuity -compounded value -future value -present value

present value

The value of any asset is the ______. -present value of the sum of all future cash flows it is expected to provide over the relevant time period -sum of all compounded future cash flows it is expected to provide over the relevant time period -sum of all future cash flows it is expected to provide over the relevant time period -sum of the present values of all future cash flows it is expected to provide over the relevant time period

sum of the present values of all future cash flows it is expected to provide over the relevant time period

Stock purchase warrants are instruments that give their holders ________. -the obligation to sell a certain number of shares of the issuer's preferred stock at a specified price over a certain period of time -the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time -the right to sell a certain number of shares of the issue's common stock at a specified price over a certain period of time -the obligation to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time

the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time

The process that links risk and return in order to determine the worth of an asset is termed _______. -discounting -valuation -compounding -securitization

valuation

5 categories of bonds

zero coupon bonds, junk bonds, floating-rate bonds, extendible notes, and putable bonds.

What is the current price of a $1,000 par value bond maturing in 12 years with a coupon rate of 14%, paid semiannually, that has YTM of 13%? -$1,060 -$1,090 -$1,073 -$604

$1,060

Janice would like to send her parents on a cruise for their 25th wedding anniversary. She has priced the cruise at $15,000, and she has 5 years to accumulate this money. How much must Janice deposit annually at the end of each year in an account paying 10 percent interest in order to have enough money to send her parents on the cruise? -$2,457 -$3,000 -$2,234 -$1,862

$2,457

You have been offered a project paying $300 at the beginning of each year for the next 20 years. What is the maximum amount of money you would invest in this project if you expect 9 percent rate of return to your investment? -$2,985 -$2,739 -$15,348 -$16,729

$2,985

A generous benefactor to a local ballet plans to make a one-time endowment that would provide the ballet with $150,000 per year into perpetuity. The rate of interest is expected to be 5 percent for all future time periods. How large must the endowment be? -$750,000 -$300,000 -$1,428,571 -$3,000,000

$3,000,000

Otto is planning for his son's college education to begin ten years from today. He estimates the end-of-year tuition, books, and living expenses to be $10,000 per year for a four-year degree. How much must Otto deposit today, at an interest rate of 12 percent, for his son to be able to withdraw $10,000 per year for four years of college? -$40,000 -$12,880 -$9,780 -$18,950

$9,780

Ai Lun, a management trainee at a large New York-based bank, is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 3 percent, and consumer prices have been rising steadily at a 2% rate for several years. What should Ai Lun's estimate of the real rate be? -3% -5% -1% -2%

1%

How many years does it take for $100 to grow to $200 if invested at a 5% annual rate of interest (APY)? -11.38 -14.21 -14.89 -15.56

14.21

Nico Corp issued bonds bearing a coupon rate of 12%, pay coupons semiannually, have 3 years remaining to maturity, and are currently priced at $940 per bond. What is the yield to maturity? -12% -13.99% -15.25% -14.54%

14.54%

Suppose the expectations hypothesis is true. The current rate of return on a one-year bond is 3%, and the current rate of return on a 2-year bond is 2.5%. What is the expected rate of return next year on a one-year bond? -1% -.5% -2% -1.5%

2%

The future value of $200 received today and deposited at 9 percent for three years is approximately ________. -252 -154 -248 -259

259

The chance that interest rates will change and thereby change the required return and bond value. Rising rates, which result in decreasing bond values, are of greatest concern.

Interest rate risk

You receive $1,000 in 1 year, $1,200 in 2 years, and $1,300 in 3 years. The present value today of these receipts is __________ if the opportunity cost is 4 percent. -3,227 -3,044 -4,036 -2,500

PV(NPV) = 3,227

Provisions in a bond indenture specifying certain record-keeping and general business practices that the bond issuer must follow; normally, they do not place a burden on a financially sound business.

Standard debt provisions

The relationship between the maturity and rate of return for bonds with similar levels of risk.

Term structure of interest rates.

The contractual annual rate of interest charged by a lender or promised by a borrower.

Nominal or stated annual rate

The actual rate of interest charged by the supplier of funds and paid by the demander.

Nominal rate of interest

The present value of an ordinary annuity of $2,350 each year for eight years, assuming an opportunity cost of 11 percent, is _______. -$13,424 -$30,935 -$12,093 -$27,870

$12,093

Your current income is $50,000 per year, and you would like to maintain your current standard of living (i.e. your purchasing power) when you retire. If you expect to retire in 30 years and expect inflation to average 3% over the next 30 years, what amount of annual income will you need to live at the same comfort level in 30 years? -$20,599 -$51,500 -$95,000 -$121,363

$121,363

The future value of $100 received today and deposited in an account for four years paying semiannual interest of 6 percent is _______. -$134 -$450 -$889 -$127

$127

Find the present value of the following stream of a firm's cash flows, assuming that the firm's opportunity cost is 14 percent. 1-5yrs - $20,000/yr 6-10yrs - $35,000/yr -$149,417 -$485,897 -$104,322 -$131,068

$131,068

Bill plans to fund his individual retirement account (IRA) by contributing $2,000 at the end of each year for the next 20 years. If Bill can earn 12 percent on his contributions, how much will he have at the end of the twentieth year? -$144,105 -$19,293 -$14,939 -$40,000

$144,105

Rita borrows $4,500 from the bank at 9 percent annually compounded interest to be repaid in three equal annual installments. The interest paid in the third year is _______. -$147 -$405 -$352 -$278

$147

A college received a contribution to its endowment fund of $2 million. It can never touch the principal, but can use the earnings. At an assumed interest rate of 9.5 percent, how much can the college earn to help its operations each year? -$19,000 -$18,000 -$95,000 -$190,000

$190,000

Find the future value at the end of year 3 of the following stream of cash flows received at the end of each year, assuming the firm can earn 17 percent on its investments. 1yr - $3,000 2yr - $6,000 3yr - $9,000 -$27,551 -$23,548 -$20,127 -$16,320

$20,127

Gina has planned to start her college education four years from now. To pay for her college education, she has decided to save $1,000 a quarter for the next four years in an investment account paying 12 percent interest. How much will she have at the end of the fourth year. -$1,574 -$16,000 -$19,116 -$20,157

$20,157

Hayley makes annual end-of-year payments of $6,260.96 on a five-year loan with an 8 percent interest rate. The original principal amount was ________. -$30,000 -$20,000 -$25,000 -$31,000

$25,000

The future value of $200 received today and deposited at 8 percent for three years is approximately. -$248 -$159 -$252 -$253

$252

The present value of a $20,000 perpetuity at a 7 percent discount rate is ______. -$140,000 -$285,714 -$325,000 -$186,915

$285,714

The future value of a $2,000 annuity due deposited at 8 percent compounded annually for each of the next 10 years is _______. -$28,973 -$14,494 -$13,420 -$31,291

$31,291

The present value of $100 to be received 10 years from today, assuming an opportunity cost of 9 percent, is approximately. -$190 -$42 -$237 -$10

$42

Coupon 11.0 Last price 65.5 Yield 16.8% Based on the Table 6.1, assume this bond's face value is $1,000. What is the bond's current market price? -$650 -$65.50 -$655.00 -$6,550

$655

You receive $100 today, $200 in one year, and $300 in two years. If you deposit these cash flows into an account earning 12 percent, the value in the account three years from now is _______. -less than $600 -$727 -$649 -$815

$727

Ashley owns stock in a company which has consistently paid a growing dividend over the last five years. The first year Ashley owned the stock, she received $1.71 per share and in the fifth year, she received $2.89 per share. What is the growth rate of the dividends over the last five years? -12 percent -7 percent -5 percent -11 percent

11 percent

How long would it take for you to save an adequate amount for retirement if you deposit $40,000 per year into an account beginning today that pays 12 percent per year if you wish to have a total of $1,000,000 at retirement? -10.5 years -11.5 years -12.2 years -14.8 years

11.5 years

The present value of $130 to be received 10 years from today, assuming an opportunity cost of 10 percent, is approximately _______. -337 -77 -799 -50

50

What effective annual rate of return (EAR) would Rayne need to earn if she deposits $1,000 per month into an account beginning one month from today in order to have a total of $1,000,000 in 30 years? -6.14% -4.87% -6.55% -5.98%

6.14%

What is the approximate yield to maturity for a $1,000 par value bond selling for $1,120 that matures in 6 years and pays 12 percent interest annually? -12% -8.5% -9.3% -13.2%

9.3%

Assume Julian has a choice between two deposit accounts. Account A has an annual percentage rate of 7.55 percent but with interest compounded monthly. Account B has an annual percentage rate of 7.45 percent with interest compounded continuously. Which account provides the highest effective annual return? -Account A -Account B -Both provide the same effective annual return -We don't have sufficient information to make a choice.

Account A

The nominal annual rate. "Truth-in-lending" laws

Annual percentage rate (APR)

The effective annual rate of savings product pays. "Truth-in-savings" laws.

Annual percentage yield (APY)

A level periodic stream of cash flows.

Annuity

Is a stream of equal periodic cash flows over a specified period.

Annuity

The cash flows occur at the beginning of each period.

Annuity due

The value of an asset is the future value of all present cash flows it is expected to provide. T/F

False - flip present and future

A legal document that specifies both the rights of the bond-holders and the duties of the issuing corporation.

Bond indenture

A feature included in nearly all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated call price prior to maturity

Call feature

The amount by which a bond's call price exceeds its par value.

Call premium

The started price at which a bond may be repurchased, by use of a call feature, prior to maturity.

Call price

Is interest paid on a investment's original principal and on interest that has accumulated over previous periods.

Compound Interest

A features of convertible bonds that allows bondholders to change each bond into a started number of shares of common stock.

Conversion feature

A long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms

Corporate bond

The percentage of a bond's par value that will be paid annually, typically in two equal semiannual payments, as interest

Coupon rate

a measure of a bond's cash return for the year; calculated by dividing the bond's annual interest payment by tis current price.

Current yield

The amount by which a bond sells below its par value

Discount

The process of finding present values.

Discounting cash flows

The annual rate of interest actually paid or earned.

Effective or true annual rate (EAR)

A bond issued by an international borrower and sold to investors in countries with currencies other than the currency in which the bond is denominated.

Eurobond

The theory that the yield curve reflects investor expectations about future interest rates; an expectation of rising interest rates results in an upward-sloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve.

Expectations theory

You will receive $100 in 1 year, $200 in 2 years, and $300 in 3 years. If you can earn 13% on your investments, the future value of the receipts at the end of year 3 is ______. -512 -801 -654 -453

FV(NPV) = 654

To pay for his college education, Alan is saving $2,000 at the beginning of each year for the next nine years in a bank account paying 12 percent interest. Rounded to the nearest dollar, how much will Alan have in that amount at the end of the 9th year. -27,551 -29,951 -11,128 -33,097

FVA = 33,097

Everything else being equal, the higher the discount rate, the higher the present value. T/F

False

For any interest rate and for any period of time, the more frequently interest is compounded, the greater the amount of money that has to be invested today in order to accumulate a given future amount. T/F

False

When computing an interest or growth rate, the rate will decrease with an increase in future value, holding present value and the number of periods constant. T/F

False

The calculated bond value is equal to its par value, which will never be the case when the required return is equal to the coupon rate. T/F

False - Never to Always

A yield curve that indicates that interest rates do not vary much at different maturities.

Flat yield curve

A rising trend in the prices of most goods and services.

Inflation

Usually applied to debt instruments such as banks loans or bonds; the compensation paid by the borrower of funds to the lender; from the borrower's point of view, the cost of borrowing funds.

Interest rate

David was given a gold coin originally purchased for $1 by his great aunt 50 years ago. Today the coin is valued at $289. The rate of return realized on the sale of this coin is approximately equal to ________. -9% -7.5% -12% -13%

Interest rate = 12%

A downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates.

Inverted yield curve

A general tendency to investors to prefer short-term securities.

Liquidity Preference

The theory suggesting that for any given issuer, long-term interest rates tends to be higher than short-term rates is called ________. -expectation hypothesis -market segmentation theory -interest parity theory -liquidity preference theory

Liquidity preference theory

Theory suggesting that long-term rates are generally higher than short-term rates because investors perceive short-term investments as more liquid and less risky than long-term investments. Borrowers must offer higher rates on long-term bonds to entice investors away from their preferred short-term securities.

Liquidity preference theory

A record of the payments that a borrower makes, including the interest and principal components of each payment, and the schedule shows the remaining loan balance after each payment.

Loan Amortization schedule.

Refers to a situation in which the borrower makes fixed periodic payments and gradually pays down the loan principal over time.

Loan amortization

Theory suggesting that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate; the slope of the yield curve is determined by the general relationship between the prevailing rates in each market segment.

Market segmentation theory

Valuation uses: Cash flows, timing and _______

Measure of risk

A stream of cash flow that is not an annuity, and of unequal periodic cash flows that reflect no particular pattern.

Mixed Stream

A bond issued by a state or local government body.

Municipal bond

You have been offered a project paying $300 at the end of each year for the next 20 years. Rounded to the nearest dollar, what is the maximum amount of money you would invest in this project if you expect 9 percent rate of return to your investment? -2,985 -15,348 -2,739 -16,729

PVA = 2,739

The amount of money the borrower must repay at maturity, and the value on which periodic interest payments are based.

Par value, face value, principal

Is an annuity with an infinite life, never stops providing a cash flow at the end of each year.

Perpetuity

The amount by which a bond sells above its par value

Premium

May refer to the original amount of money placed into an investment or to the balance on which an investment pays interest.

Principal

Involves four compounding periods within the year.

Quarterly compounding of interest

The rate of return on an investment measured not in dollars but in the increase in purchasing power that the investment provides. Also, it measures the rate of increase in purchasing power.

Real rate of interest

Usually applied to equity instruments such as common stock; the cost funds obtained by selling an ownership interest.

Required return

Provisions in a bond indenture that place operating and financial constraints on the borrower

Restrictive covenants

Debentures, subordinated debentures and income bonds.

Secured bonds

Involves an investment with two compounding period within the year.

Semiannual compounding of interest

A lump sum amount either currently held or expected at some future date.

Single Amount

Instruments that give their holders the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time.

Stock purchase warrants

In comparing an ordinary annuity and an annuity due, which of the following is TRUE? -The PV of an annuity due is always less than the future value of an otherwise identical ordinary annuity, since one less payment is received with an annuity due. -The FV of an ordinary annuity is always greater than the future value of an otherwise identical annuity due. -The FV of an annuity due is always greater than the FV of an otherwise identical ordinary annuity -all things being equal, one would prefer to receive an ordinary annuity compared to an annuity due.

The FV of an annuity due is always greater than the FV of an otherwise identical ordinary annuity

Which of the following is TRUE of the risk premium? -junk bonds have a lower risk premium investment-grade bonds. -The lower-rated corporate issues have a higher risk premium than that of the higher rated corporate issues. -T-bills have a higher risk premium compared with Treasury bonds. -government bonds have a higher risk premium compared with corporate bonds.

The lower-rated corporate issues have a higher risk premium than that of the higher rated corporate issues.

Refers to the observation that it is better to receive money sooner than later.

Time Value of Money

Depicts the cash flows associated with a given investment

Timeline

A Eurobond is a bond issues by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated. T/F

True

A bond issued by an American company that is denominated in Swiss Francs and sold in Switzerland would be an example of a foreign bond. T/F

True

An annuity due is a stream of equal cash flows with each cash flow arriving at the beginning of each period. T/F

True

As a bond approaches maturity, the price of the bond will approach its par value until, the bond is worth its face value at maturity. T/F

True

In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion of each payment declines over the life of the loan. T/F

True

Interest rate risk is the risk that results from the changes in interest rates and thereby impact the bond value. T/F

True

Investors will demand a higher nominal rate of return on risky investments. T/F

True

Restrictive covenants are contractual clauses in long-term debt agreements that place certain operating and financial constraints on the borrower. T/F

True

The process of taking cash flow that is received or paid in the future and stating that cash flow in present value terms is called discounting. T/F

True

The term structure of interest rates is a graphical presentation of the relationship between the maturity and rate of return. T/F

True

Although no investment is truly risk free, ______ are generally viewed as the closest thing we can come to in the real world to a risk-free investment. -secured bonds -zero-coupon bonds -U.S. Treasury securities -AAA-rated corporate bonds

U.S. Treasury securities

Mortgage bonds, collateral trust bonds, and equipment truest certificates

Unsecured bonds

Is the process that links risk and return to determine the worth of an asset.

Valuation

A graphic depiction of the term structure of interest rates.

Yield curve

Compound annual rate of return earned on a debt security purchased on a given day and held to maturity. an estimate of the market's required return on a particular bond.

Yield to maturity (YTM)

_______ is the amount earned on a deposit that has become the part of the principal at the end of a specified time period. -compound interest -discount interest -primary interest -future value

compound interest

You invest a certain amount of money today. The process of determining how much money that investment will produce in the future is called _________. -compounding -annuitizing the cash flows -discounting -present value

compounding

In the basic valuation model, risk is generally incorporated into the _______. -discount rate -total value -cash flows -timing

discount rate

Assume the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10 year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is _______. -flat -downward sloping -normal -upward sloping

downward sloping

According to the expectations hypothesis, an _______ yield curve reflects lower expected future rates of interest. -linear -downward-sloping -upward-sloping -flat

downward-sloping