Chapter 5 - Canvas Quiz Answers (plus written questions)

Your goal is to have $1 million in your retirement savings on the day you retire. To fund this goal, you will make one lump sum deposit today. If you plan to retire ________ rather than ________ and earn a ________ rate of interest, then you can deposit a smaller lump sum today. -sooner; later; low -sooner; later; high -later; sooner; high -later; sooner; low -today; later; high

later; sooner; high

Cash flows occurring in different periods should not be compared unless: -interest rates are expected to be stable -the flows occur no more than one year from each other -high rates of interest can be earned on the flows. -the flows have been discounted to a common date.

the flows have been discounted to a common date.

The interest earned on both the initial principal and the interest reinvested from prior periods is called: -free interest. -dual interest. -simple interest. -interest on interest. -compound interest.

compound interest.

The process of determining the present value of future cash flows in order to know their value today is referred to as: -compound interest valuation. -interest on interest valuation. -discounted cash flow valuation. -future value interest factoring. -complex factoring.

discounted cash flow valuation.

Luke is calculating the present value of a bonus he will receive next year. The process he is using is called: -growth analysis. -discounting. -accumulating. -compounding. -reducing.

discounting.

You are investing $100 today in a savings account. Which one of the following terms refers to the total value of this investment one year from now? -Future value -Present value -Principal amount -Discounted value -Invested principal

Future value

Yoda invested $1,000 ten years ago and expected to have $1,800 today He has neither added nor withdrawn any money since his initial investment. All interest was reinvested and compounded annually. As it turns out, he only has $1,680 in his account today. Which one of the following must be true? -He earned simple interest rather than compound interest. -He earned a lower interest rate than he expected. -He did not earn any interest on interest as he expected. -He ignored the Rule of 72 which caused his account to decrease in value. -The future value interest factor turned out to be higher than he expected.

He earned a lower interest rate than he expected.

Given a set future value, which of the following will contribute to a lower present value? -Higher discount rate -Fewer time periods -Less frequent discounting -Lower discount factor

Higher discount rate

TMCC, a subsidiary of Toyota motor, offered some securities for sales to the public on March 28,2008. Under the terms of the deal, TMCC promised to repay the owner of one of these securities $100,000 on March 28,2038, but investors would receive nothing until then. Investors paid TMCC $24,099 on March 28, 2008, for the promise of a $100,000 payment 30 years later. Why would TMCC be willing to accept such a small amount today ($24,099) in exchange for a promise to repay about four times that ($100,000) in the future?

It's a reflection of the time value of money. TMCC gets to use the $24,099. If TMCC uses it wisely, it will be worth more than $100,000 in 30 years.

TMCC, a subsidiary of Toyota motor, offered some securities for sales to the public on March 28,2008. Under the terms of the deal, TMCC promised to repay the owner of one of these securities $100,000 on March 28,2038, but investors would receive nothing until then. Investors paid TMCC $24,099 on March 28, 2008, for the promise of a $100,000 payment 30 years later. Suppose that when TMCC offered the security for $24,099 the US Treasury had offered an essentially identical security. Do you think i t would have had a higher or lower price? Why?

The Treasury security would have a somewhat higher price because the Treasury is the strongest of all borrowers...remember, it can just tax everyone to repay lenders

TMCC, a subsidiary of Toyota motor, offered some securities for sales to the public on March 28,2008. Under the terms of the deal, TMCC promised to repay the owner of one of these securities $100,000 on March 28,2038, but investors would receive nothing until then. Investors paid TMCC $24,099 on March 28, 2008, for the promise of a $100,000 payment 30 years later. Would you be willing to paty $24,099 today in exchange for $100,000 in 30 years? What would be the key considerations in answering yes or no? Would your answer depend on who is making the promise?

The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we will actually get the $100,000? Thus, our answer does depend on who is making the promise to repay.

This afternoon, instead of spending a gazillion dollars at Starbucks, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in 40 years. Which one of the following statements is correct? -The interest you earn in Year 6 will equal the interest you earn in Year 10. -The interest amount you earn will double in value every year. -The total amount of interest you will earn will equal $1,000 × .06 × 40. -The present value of this investment is equal to $1,000. -The future value of this amount is equal to $1,000 × (1 + 40).06.

The present value of this investment is equal to $1,000.

TMCC, a subsidiary of Toyota motor, offered some securities for sales to the public on March 28,2008. Under the terms of the deal, TMCC promised to repay the owner of one of these securities $100,000 on March 28,2038, but investors would receive nothing until then. Investors paid TMCC $24,099 on March 28, 2008, for the promise of a $100,000 payment 30 years later. The TMCC security is bought and sold on NYSE. If you looked at the price today do you think the price would exceed the $24,099 original price? If you looked in the year 2019, do you think the price would be higher or lower than today's price? Why?

The price would be higher because, as time passes, the price of the security will tend to rise toward $100,000. This rise is just a reflection of the time value of money. As time passes, the time until receipt of the $100,000 grows shorter, and the present value rises. In 2019, the price will probably be higher for the same reason. We cannot be sure, however, because interest rates could be much higher, or TMCC's financial position could deteriorate. Either event would tend to depress the security's price.

TMCC, a subsidiary of Toyota motor, offered some securities for sales to the public on March 28,2008. Under the terms of the deal, TMCC promised to repay the owner of one of these securities $100,000 on March 28,2038, but investors would receive nothing until then. Investors paid TMCC $24,099 on March 28, 2008, for the promise of a $100,000 payment 30 years later. TMCC has the right to repurchase the securities on the anniversary date at a price established when the securities were issued (this is a feature of the of this particular deal).What impact does this feature have on the desirability of this security as an investment?

This will probably make the security less desirable. TMCC will only repurchase the security prior to maturity if it is to its advantage, i.e., interest rates decline. Given the drop in interest rates needed to make this viable for TMCC, it is unlikely the company will repurchase the security. This is an example of a "call" feature. Such features are discussed at length in a later chapter.