Finance Chapter 5 conceptual questions

preferred

A ___________ stock with no maturity is an example of a perpetuity.

more than; earn

A dollar in hand today is worth ________ a dollar to be received in the future because if you had it now you could invest that dollar and _________ interest.

faster

A graph of the compounding process shows how any sum grows over time at various interest rates. The greater the interest rate, the __________ the growth rate.

higher

A graph of the discounting process shows how the present value of any sum to be received in the future decreases and approaches 0 as the years to receipt increases, and the present value declines faster at __________ interest rates.

true

A lender should prefer to lend at a rate of 10% with semiannual compounding, but a borrower would prefer a loan with a rate of 10%, annual compounding. True or false?

additional; additional

Each payment of an annuity due is compounded for one ________ period, so the future value of an annuity due is equal to the future value of an ordinary annuity compounded for one __________ period.

compounding

Finding the future value (FV), or ___________, is the process of going from today's values to future amounts

discounting

Finding the present value (PV) is called ___________, and it is simply the reverse of compounding

largest, decreases. smallest, increases

Interest is ______ in the first period and _________ over the life of the loan, while the principal repayment is __________ in the first period and it _______ thereafter.

true

Is this statement true or false? If you calculated the value of an ordinary annuity, you could find the value of the corresponding annuity due by multiplying the FV of the ordinary annuity by (1 + I), because this would take into account that each annuity due payment occurs one year earlier.

discount cash flow (DCF)

Of all the techniques used in finance, none is more important than the concept of time value of money (TVM), also called __________ analysis.

d. Both B and C

The concept of opportunity cost is described in which of the following statements? a. The monetary value of an exchange of goods for services or the opportunity to do something b. The value of what certain resources could have produced had they been used in the best alternative way c. The cost of choosing between two alternatives d. Both B and C

present

The fundamental goal of financial management is to maximize the firm's value, and the value of any asset is the ___________ value of its expected future cash flows.

ordinary annuity

The future value of an __________, FVAN, is the total amount one would have at the end of the annuity period if each payment (PMT) were invested at a given interest rate and held to the end of the annuity period

compound interest

Time value of money uses the concept of _____________ rather than simple interest.

c. The FV as shown on a time line is always the cash flow at Time = 1.

Which of the following statements is FALSE? a. Cash flows do not have to occur for every period shown on the time line. A lump sum cash flow can be depicted as easily as annuities on a time line. b. Time lines typically show dollars below the line and years above the line. c. The FV as shown on a time line is always the cash flow at Time = 1. d. Time lines can show cash flows that occur over years, quarters, or any other periods. e. Time lines put verbal information into a diagram that is useful for seeing the cash flows that occur, when they occur, and the interest rate used in the analysis.

c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment.

Which of the following statements is TRUE? a. A deposit will grow faster if simple interest rather than compound interest is paid. b. It would be better to both lend and borrow money at a rate of 6%, simple interest, rather than at a rate of 6%, compound interest. c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment.

b. An amortized loan is a type of loan that requires regular, fixed payments over the life of the loan with the loan balance decreasing over time.

Which of the following statements regarding amortization is CORRECT? a. Mortgages, car loans, and student loan are not examples of amortized loans. b. An amortized loan is a type of loan that requires regular, fixed payments over the life of the loan with the loan balance decreasing over time. c. An amortization schedule provides information regarding the terms of the loan, such as the interest rate and the length of the loan (or maturity); however, it does not provide detailed information that the borrower can use to determine the breakdown of the loan payment into interest and principal repayment. d. All the above statements are true. e. None of the statements is true.

d. If the interest rate is greater than zero, then the future value of an ordinary annuity is greater than the future value of an annuity due. This occurs because the last payment of the ordinary annuity earns interest, while the last payment of the annuity due does not.

Which of the following statements regarding annuities is NOT CORRECT? a. An annuity due is like an ordinary annuity with the exception that payments occur at the beginning of each period, instead of at the end of each period. b. The general assumption in finance is that annuity payments occur at the end of the period, so this type of payment is referred to as an ordinary annuity. c. An annuity is a recurring payment, at set intervals, for a given amount of time. d. If the interest rate is greater than zero, then the future value of an ordinary annuity is greater than the future value of an annuity due. This occurs because the last payment of the ordinary annuity earns interest, while the last payment of the annuity due does not.

amortized loans

a loan that is payed in equal payments over its life. Some common types of these are automobile loans, home mortgage loans, and business loans. Each loan payment consists of interest and repayment of principal.

uneven, or nonconstant, cash flows

a series of cash flows where the amount varies from one period to the next

growing annuity

a series of payments that grow at a constant rate

perpetuity

a stream of equal payments at fixed intervals expected to continue forever

annuity due

an annuity whose payments occur at the beginning of each period

ordinary (deferred) annuity

an annuity whose payments occur at the end of each period

single payments

are known as lump sums

nominal interest rate

the contracted or quoted or stated interest rate. is quoted by borrowers and lenders, and it is also called the annual percentage rate (APR).

annuity

when the payments are equal and are made at fixed intervals, the series is an