FIN chap 5
6) Why, in general, do investment opportunities offer a rate greater than that offered by U.S. Treasury securities for the same horizon? A) Most investment opportunities offer far greater risk than those offered by U.S. Treasury securities. B) The return from U.S. Treasury securities generally attracts less tax than the returns from other investments. C) The opportunity cost of capital for a given horizon is generally based on U.S. Treasury securities with that same horizon. D) U.S. Treasury securities are generally considered to be the best alternative to most investments. Answer:
A) Most investment opportunities offer far greater risk than those offered by U.S. Treasury securities.
41) When computing a present value, which of the following is TRUE? A) You should adjust the discount rate to match the time period of the cash flows. B) You should adjust the future value to match the present value. C) You should adjust the time period to match the present value. D) You should adjust the cash flows to match the time period of the discount rate. Answer:
A) You should adjust the discount rate to match the time period of the cash flows.
5) What is the *effective annual rate (EAR)*? A) the interest rate that would earn the same interest with annual compounding B) the ratio of the number of the annual percentage rate to the number of compounding periods per year C) the discount rate for an n-year time interval, where n may be more than one year or less than or equal to one year (a fraction) D) the cash flows from an investment over a one-year period divided by the number of times that interest is compounded during the year
A) the interest rate that would earn the same interest with annual compounding
10) Which of the following best describes the *annual percentage rate*? A) the quoted interest rate which considered with the compounding period gives the effective interest rate B) the effective annual rate after compounding is taken into account C) the discount rate when compounded more than once a year or less than once a year D) the discount rate when it is divided by the number of of times it is compounded in a year
A) the quoted interest rate which considered with the compounding period gives the effective interest rate
14) In an effort to maintain price stability, it is expected that the European Central Bank will raise interest rates in the future. Which of the following is the most likely effect of such an action on short- and long-term interest rates in Europe? A) Long-term interest rates will tend to be higher than short-term interest rates. B) Long-term interest rates will be about the same as short-term interest rates. C) Both long- and short-term interest rates would be expected to fall sharply. D) No relative change in short and long term interest rates could be predicted.
Answer: A) Long-term interest rates will tend to be higher than short-term interest rates.
10) In which of the following situations would the reserve bank in a certain country be most likely to lower interest rates? A) The economy is growing slowly or not at all. B) Inflation is rising rapidly. C) The level of investment is very low. D) The rate of savings is extremely high.
Answer: AA) The economy is growing slowly or not at all
4) Which of the following would be *LEAST likely to lower* the interest rate that a bank offers a borrower? A) The number of borrowers seeking funds is low. B) The expected inflation rate is expected to be low. C) The borrower is judged to have a low degree of risk. D) The investment will be for a long period of time.
Answer: D D) The investment will be for a long period of time
8) Historically, why have high inflation rates tended to be associated with high nominal interest rates? A) Individuals will spend more when they expect their investments to increase in value. B) Growth in investment and savings is encouraged when consumers are judged to be overspending. C) High inflation leads to a decrease in purchasing power and thus increases the attractiveness of investment over consumption in the short term. D) The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present.
Answer: D D) The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present.
9) When the costs of an investment come before that investment's benefits, what will be the the effect of a rise in interest rates on the attractiveness of that investment to potential investors? A) It will make it more attractive, since it will increase the investment's net present value (NPV). B) It will make it more attractive, since it will decrease the investment's net present value (NPV). C) It will make it less attractive, since it will increase the investment's net present value (NPV). D) It will make it less attractive, since it will decrease the investment's net present value (NPV).
Answer: DD) It will make it less attractive, since it will decrease the investment's net present value (NPV).
2) The real interest rate is the rate of growth of one's purchasing power due to money invested. T/F
Answer: FALSE
2) The term "opportunity" in opportunity cost of capital comes from the fact that any worthwhile opportunity for investment will have a cost: the risk to the capital invested. T/F
Answer: FALSE
2) When there are large numbers of people looking to save their money and there is *little demand for loans*, one would expect *interest rates to be high*. T/F
Answer: FALSE
3) The annual percentage rate indicates the amount of interest, including the effect of any compounding. T/F
Answer: FALSE
5.2 Application: Discount Rates and Loans 1) Joe borrows $100,000 and agrees to repay the principal, plus 7% APR interest compounded monthly, at the end of three years. Joe has taken out an amortizing loan. T/F
Answer: FALSE
3) Quality adjustments to changes in the CPI most often result in reductions to the inflation rate calculated from it. T/F
Answer: TRUE
5.1 Interest Rate Quotes and Adjustments 1) When you borrow money, the interest rate on the borrowed money is the price you pay to be able to convert your future loan payments into money today. T/F
Answer: TRUE
5.3 The Determinants of Interest Rates 1) Market forces determine interest rates based ultimately on the willingness of individuals, banks, and firms to borrow, save, and lend. T/F
Answer: TRUE
5.4 The Opportunity Cost of Capital 1) The opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted. T/F
Answer: TRUE
40) Which of the following is/are TRUE? I. The EAR can never exceed the APR. II. The APR can never exceed the EAR. III. The APR and EAR can never be equal. A) Only I. is true. B) Only II. is true. C) Only II. & III. are true. D) Only I. & III. are true. Answer:
B) Only II. is true.
27) Inflation is calculated as the rate of change in the: A) Unemployment rate. B) Gross Domestic Product. C) Consumer Price Index. D) Risk-free rate. Answer:
C) Consumer Price Index.
4) What, typically, is used to calculate the opportunity cost of capital on a risk-free investment? A) the best available expected return offered in any investment available in the market B) the interest rate on U.S. Treasury securities with the same term C) the interest rate of any investments alternatives that are available D) the best rate of return offered by U.S. Treasury securities Answer:
B) the interest rate on U.S. Treasury securities with the same term
28) The yield curve is typically: A) downward sloping. B) upward sloping. C) flat. D) inverted. Answer:
B) upward sloping
13) In which of the following situations would it not be appropriate to use the following formula: PV = C0 + C1/(1 + r) + C2/(1 + r)2 + . . . . + Cn/(1 + r)n when determining the present value (PV) of a cash flow stream? A) when yield curves are flat B) when short-term and long-term interest rates vary widely C) when the inflation rate is high D) when the discount rate is high
B) when short-term and long-term interest rates vary widely
8) Which of the following statements is FALSE? A) The actual return kept by an investor will depend on how the interest is taxed. B) The equivalent after-tax interest rate is r(1 - τ). C) The highest interest rate, for a given horizon, is the rate paid on U.S. Treasury securities. D) It is important to use a discount rate that matches both the horizon and the risk of the cash flows. Answer:
C) The highest interest rate, for a given horizon, is the rate paid on U.S. Treasury securities.
22) What is the shape of the yield curve and what expectations are investors likely to have about future interest rates? A) inverted; higher B) normal; higher C) inverted; lower D) normal; lower
C) inverted; lower
15) A bank offers an account with an APR of 6% and an EAR of 6.09%. How does the bank compound interest for this account? A) weekly compounding B) monthly compounding C) semiannual compounding D) annual compounding Answer: C
C) semiannual compounding
7) Which of the following statements is FALSE? A) The investor's opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term of the cash flows being discounted. B) Interest rates we observe in the market will vary based on quoting conventions, the term of investment, and risk. C) The opportunity cost of capital is the return the investor forgoes when the investor takes on a new investment. D) For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term. Answer:
D) For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term.
19) Which of the following statements is FALSE? A) The interest rates that banks offer on investments or charge on loans depends on the horizon of the investment or loan. B) The Federal Reserve determines very short-term interest rates through its influence on the federal funds rate. C) The interest rates that are quoted by banks and other financial institutions are nominal interest rates. D) Fundamentally, interest rates are determined by the Federal Reserve. Answer:
D) Fundamentally, interest rates are determined by the Federal Reserve.
19) Which of the following statements is FALSE? A) Because interest rates may be quoted for different time intervals, it is often necessary to adjust the interest rate to a time period that matches that of our cash flows. B) The effective annual rate indicates the amount of interest that will be earned at the end of one year. C) The annual percentage rate indicates the amount of simple interest earned in one year. D) The annual percentage rate indicates the amount of interest including the effect of compounding. Answer:
D) The annual percentage rate indicates the amount of interest including the effect of compounding.
17) Which of the following reasons for considering long-term loans inherently more risky than short-term loans is most accurate? A) There is a greater chance that a borrower will default in a longer time-frame. B) The penalties for closing out a long term loan early make them unattractive to many investors. C) Long term loans typically have ongoing costs that accumulate over the life of the loan. D) The loan values are very sensitive to changes in market interest rates. Answer:
D) The loan values are very sensitive to changes in market interest rates.
5) Which of the following formulas gives you the growth in purchasing power? A) growth of money + growth of prices B) (1 + real rate) / (1 + nominal rate) C) (1 + inflation rate) / (1 + nominal rate) D) growth of money / growth of prices
D) growth of money / growth of prices
4) A pottery factory purchases a continuous belt conveyor kiln for $50,000. A 6.5% APR loan with monthly payments is taken out to purchase the kiln. If the monthly payments are $501, over what term is this loan being paid? A) 10 years B) 11 years C) 12 years D) 13 years Answer: C
Explanation: C) Calculate N when PV of ordinary annuity = $50,000, periodic interest = 6.5/12%, and monthly payments = $501.
