chapter 4

17. All else equal, the future value of a lump-sum amount invested today will increase if the

number of compounding periods is increased.

8. What is the term used to describe an annuity with an infinite life?

perpetuity

3. As the discount rate increases without limit, the present value of the future cash inflows

Approaches zero.

1. Given some amount to be received several years in the future, if the interest rate increases, the present value of the future amount will

Be lower.

5. Why is the present value of an amount to be received (paid) in the future less than the future amount?

Investors have the opportunity to earn positive rates of return, so any amount invested today should grow to a larger amount in the future.

19. Suppose that the present value of receiving a guaranteed $450 in two years is $385.80. The opportunity rate of return on similar risk investments is 8 percent. According to this information, all else equal, which of the following statements is correct?

No investor should be willing to pay more than $385.80 for such an investment.

10. Suppose someone offered you your choice of two equally risky annuities, each paying $5,000 per year for 5 years. One is an annuity due, while the other is a regular (or deferred) annuity. If you are a rational wealth-maximizing investor which annuity would you choose?

The annuity due.

2. You have determined the profitability of a planned project by finding the present value of all the cash flows form that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows?

The discount rate decreases.

13. A $10,000 loan is to be amortized over 5 years, with annual end-of-year payments. Given the following facts, which of these statements is correct?

The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were higher.

18. Susan just signed a long-term lease on a townhouse in New York City (near Central Park) that requires her to make equal monthly payments for the next five years. The payments Susan has promised to make represent a(n) __________ for the landlord.

annuity due

6. By definition, what type of annuity best describes payments such as rent and magazine subscriptions (assuming the costs do not change over time)?

annuity due

15. All else equal, if you expect to receive a certain amount in the future, say, $500 in ten (10) years, the present value of that future amount will be lowest if the interest earned on such investments is compounded

daily

9. Everything else equal, which of the following conditions will result in the lowest present value of an amount to be received in the future?

daily compounding

7. What is the effective annual return (EAR) for an investment that pays 10 percent compounded annually?

equal to 10 percent

16. Which of the following payments (receipts) would probably not be considered an annuity due? Based on your knowledge and using logic, think about the timing of the payments.

interest payments associated with a corporate bond that was issued today