Finance Exam 2
"PMT" in the FV Formula tells us the periodic mortgage payments for a fixed-rate fully amortized loan
False, PV formula
Relationships of PV, r, and n with FV
If PV increases FV increases if r increases FV increases if n increases FV increases
If you buy a bond at a discount and hold it to maturity, you will experience a capital gain
True
in bond problems r = ?
YTM
maturity premium
borrowing for a longer period of time equals a higher premium
in bond problems pmt = ?
coupon
h
inflation rate
3 golden rules for bonds
1) r, n, pmt must all have equal frequencies 2) semi annual bonds: coupon=annual coupon/2, # of years x2, and r=YTM/2 3) price of bond at any point in time is present value of remaining cash flows
EAR
Effective annual rate
a $1,000 par value bond with an annual coupon rate of 5% would pay $100 in interest every 6 months
False, $25 every 6 months
there are 4 formulas on our formula sheet that contain the variable PMT
False, 3
There are a total of 3 variables in the basic TVM formulas
False, 4 variables FV, PV, n, r
Ceteris paribus, as the frequency of compounding increases, the APR will exceed the EAR by greater and greater amounts
False, EAR will exceed APR
the FV tells us the one time deposit we must make to reach a targeted retirement savings goal
False, PV
PVs are later values and FVs are earlier values
False, PVs are earlier FVs are later
PVs are rightward on a time line and FVs are leftward on the timeline
False, PVs are leftward, FVs are rightward
The periodic rate will always be greater than the APR
False, The periodic rate will always be smaller than APR, unless it is for every 2 years
the YTM on a premium bond will be above its coupon rate
False, YTM less than coupon rate
We can find the nominal interest rate by subtracting the default and maturity premiums from the sum of the real rate and inflation
False, add them
You cant go wrong by purchasing zero-coupon bonds at a premium
False, always at a discount
interest rates were high in the late 1970s and early 1980s because of low default premiums
False, because of inflation
We can find the amount needed to pay off a mortgage loan at any point in time by solving for the FV of the remaining payments
False, by solving for PV
Capital losses always increase the investor's rate of return
False, decrease
par bonds always sell for less than par value
False, equal to par value
For fixed-rate fully amortized mortgage loans, more of the fixed payment goes towards interest as we approach the end of the loan term
False, goes towards the principal
In the period 1950-1999 changes in the real rate were the main factor causing nominal interest rates to change
False, inflation
The interest part of a fixed mortgage loan payment can be found by multiplying the periodic interest rate by the ending balance for a given period
False, multiplying the periodic interest rate by the beginning balance
Discount bonds are always worth less than par value at maturity
False, not price at time of maturity
Bond prices move in the same direction as market interest rates
False, opposite direction (inverse)
The penalty for spending before earning is the interest rate from the point of view of the creditor
False, point of view of the borrower
The fisher Effect illustrates the inverse relationship between inflation and nominal interest rates
False, positive relationship
ceteris paribus, as a depositor and for the same annual interest rate, you would prefer simple interest to compound interest
False, prefer compound
Discounting is the process used to find a FV
False, process of finding PV
at maturity, investors must repay a bond's par value to its issuer
False, receive
what is "discounted" from the PV is the interest part to arrive at the FV
False, replace discounted with compounded
PVS represent the amount that an earlier amount will grow into
False, represent initial amount
With compound interest, interest is earned every period only on the original starting point
False, simple interest compound interest is interest earned on interest
On the time line for a retirement period, "PMT" in the PV formula tells us the recurring deposits that must be made earlier in order to reach a targeted retirement savings goal
False, the FV formula
On the time line for a retirement period, the FV tells us the amount we should have accumulated by the time we retire
False, the PV
FV
Future Value at time "n"
If using a financial calculator for annuity what is PV equaled too?
PV = 0
How to consider cash flows in multiple cash flows
Separately
the right-hand side variables in the FV formula represent the 3 key factors determining stock prices
True
amortized loan is similar to...
annuities
zero coupon
coupon equals zero, or no coupons
3 different loan payments
discount loan interest only loan amortized loan
annuity
equal cash flows for a period of time
perpetuity
equal cash flows forever
amortized loan
equal periodic payments principal and interest
If you own long-term zero-coupon bonds, you would hope that interest rates would increase
false interest, rates decrease
we've discussed 4 different multiple cash flow patterns
false, 3 annuity, perpetuity, unequal
FVs represent what you need to invest earlier to have it grow into a specified later amount
false, are the amount that the investment grows into
The FV and the discount rate are inversely related
false, directly related
the number of years it would take an investment to double is approximately equal to the annual interest rate times 72
false, n=72/r
We can determine which "PMT" we're being asked to solve for by noting what the problem provides in terms of r and n
false, need FV, PV, n (fixed or forever)
lump sums are multiple cash flows
false, one cash flow
annuities are equal cash flows that go on forever
false, perpetuity goes on forever
annuities happen at...
fixed intervals, same amount
Par value
future value
the 3 perspectives
general lender borrower
who can issue bonds?
government, corporation, individual
relationships of FV, n, and r with PV
if FV increases PV increases if n increases PV decreases if r increases PV decreases
APR
interest rate for a year
bond
long term debt instrument
History: rank most important inflation real interest rate default premium maturity premium
most important: inflation maturity premium real interest rate default rate
r
nominal interest rate
m
number of payments in a year. (multiply n * m for total payments)
n
number of periods
borrower perspective
penalty for spending before earning
interest only loan
periodic interest principals at end
type of relationship between inflation and interest rate
positive
PV
present value at time zero in your time table. brings cash flows to year zero
Discount Loan
principle and interest is paid in lump sum
r*
real interest rate
compound interest
receive interest on interest
general perspective
rental price of money
lender perspective
reward for postponing spending
Default premium
risk that you wont receive money because person defaults
three factors in determining stock prices
time (-), risk(-), future value(+)
types of multiple cash flows
unequal CFs, equal CFs for a period of time, equal CFs forever
coupon
way of raising money for a corporation