Intermediate Finance Quizzes 1-3

If the future value of $1 invested today at an interest rate of r percent for n years is 9.6463, what is the present value of $1 to be received in n years at r percent interest rate?

$.01037 PV = 1/9.6463 = 0.1037.

A government bond issued in Germany has a coupon rate of 5 percent, a face value of 100 euros, and matures in 5 years. The bond pays annual interest payments. Calculate the yield to maturity of the bond (in euros) if the price of the bond is 106 euros.

3.66 percent ?

True or false. A dollar today is worth more than a dollar tomorrow if the interest rate is positive.

True

True or false. Long-term spot rates are usually higher than short-term spot rates

True

True or false. The duration of a zero-coupon bond is the same as its maturity.

True

True or false. The expectations theory implies that the only reason for a declining term structure is that investors expect spot interest rates to fall.

True

True or false. The law of one price states that the same commodity must sell at the same price in a well-functioning market.

True

True or false. The longer a bond's duration, the greater its volatility.

True

True or false. The rate of return, discount rate, hurdle rate, and opportunity cost of capital all have the same meaning.

True

True or false. U.S. Treasury bonds have almost zero default risk but are subject to inflation.

True

True or false. If the term structure of interest rates is flat, then the 9-year spot interest rate equals the 10-year spot interest rate.

True (interest rates for all durations are the same if the interest rate is flat)

True or false. The yield to maturity on a bond is really its rate of return.

True.

You would like to have enough money saved to receive $80,000 per year in perpetuity after retirement for you and your heirs. How much would you need to have saved in your retirement fund to achieve this goal? (Assume that the perpetuity payments start one year from the date of your retirement. The annual interest rate is 8 percent.)

$1,000,000 (80,000/8% = 1 mil)

Mr. X invests $1000 at 10% nominal rate for one year. If the inflation rate is 4%, what is the real value of the investment at the end of one year?

$1,058 (1100/1.04)

The present value of a $100 per year perpetuity at 10 percent per year interest rate is $1,000. What would be the present value of this perpetuity if the payments were compounded continuously?

$1049.21 ?

If the one-year discount factor is 0.90, what is the present value of $120 expected one year from today?

$108 (.9 * 120 = 108)

Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest rate is 10 percent per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her consumption next year?

$18,000 Borrow $20,000 this year to consume 60,000 + 20,000 = 80,000. Consumption next year = 40,000 - (20,000 × 1.1) = 18,000.

John House has taken a $250,000 mortgage on his house at an interest rate of 6 percent per year. If the mortgage calls for 20 equal annual payments, what is the amount of each payment?

$21,796.14

Mr. Williams expects to retire in 30 years and would like to accumulate $1 million in his pension fund. If the annual interest rate is 12 percent, how much should Mr. Williams put into his pension fund each month in order to achieve his goal? (Assume that Mr. Williams will deposit the same amount each month into his pension fund, using monthly compounding.)

$286.13 ?

A five year treasury bond with a coupon rate of 8 percent has a face value of $1000. What is the semiannual interest payment?

$40

Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest rate is 10 percent per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will be her consumption this year?

$40,000 60,000 - (22,000/1.1)

If the present value of a cash flow generated by an initial investment of $200,000 is $250,000, what is the NPV of the project?

$50,000 (-200,000 + 250,000 = 50,000)

Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a project that costs $30,000 this year, which generates an income of $36,000 next year. The market interest rate is 10 percent. What will be his consumption next year if Mr. Smith invests in the project and consumes $50,000 this year?

$52,000 Consumption next year = [40,000 - 30,000 - 50,000] × 1.1 + (60,000 + 36,000) = 52,000.

You would like to have enough money saved to receive a growing annuity for 20 years, growing at a rate of 5 percent per year, with the first payment of $50,000 occurring exactly one year after retirement. How much would you need to save in your retirement fund to achieve this goal? The interest rate is 10 percent.

$605,604.20 ?

After retirement, you expect to live for 25 years. You would like to have $75,000 income each year. How much should you have saved in your retirement account to receive this income if the annual interest rate is 9 percent per year? (Assume that the payments start one year after your retirement.)

$736,693.47

Mr. Free has $100 income this year and zero income next year. The market interest rate is 10 percent per year. If Mr. Free consumes $30 this year and invests the rest in the market, what will be his consumption next year?

$77 (100-30) * 1.1

The present value of $100,000 expected at the end of one year, at a discount rate of 25 percent per year, is

$80,000

You would like to have enough money saved after your retirement such that you and your heirs can receive $100,000 per year in perpetuity. How much would you need to have saved at the time of your retirement in order to achieve this goal? (Assume that the perpetuity payments start one year after the date of your retirement. The annual interest rate is 12.5 percent.)

$800,000 (100,000/.0125)

You just inherited a trust that will pay you $100,000 per year in perpetuity. However, the first payment will not occur for exactly four more years. Assuming an 8 percent annual interest rate, what is the value of this trust?

$992,290 ?

Disadvantages of the corporate form:

1. Agency costs 2. Double taxation 3. Cost of managing the corporation

A bond has a face value of $1000, an annual coupon rate of 7 percent, yield to maturity of 10 percent, and 20 years to maturity. The bond's duration is

10 years ?

An investment at 10 percent compounded continuously has an equivalent annual rate of

10.517 percent ?

If the present value annuity factor at 12 percent for five years is 3.6048, what is the equivalent future value annuity factor?

6.35

A bond with duration of 10 years has a yield t maturity of 10 percent. The bond's volatility (modified duration) is

9.09 years 10/1.1

If the bond's volatility is 10 percent and the interest rate goes down by .75 percent (points), then the price of the bond A. Increases by 7.50 percent B. Decreases by 10 percent C. Decreases by 7.50 percent D. Increases by .75 percent

A. Increases by 7.50 percent

Managers, shareholders, and the firm's debtholders have identical information about the value of the firm. A. True B. False

B. False

A corporation may incur agency costs because A. shareholders incur monitoring costs B. all of the responses are correct C. of the separation of ownership and management D. managers may not attempt to maximize the value of the firm to shareholders

B. all of the responses are correct

The choice of the proper mixture of debt and equity, used to finance a corporation, is also referred to as the A. investment decision. B. capital structure decision. C. capital budgeting decision. D. liquidity decision

B. capital structure decision.

Limited liability is an important feature of A. both partnerships and corporations B. corporations C. partnerships D. sole proprietorships

B. corporations

The line that connects the maximum that one can consume this year (now, on the horizontal axis) and the maximum one can consume next year A. has a slope of r. B. has a slope of - (1 + r). C. has a slope of (1 + r). D. has a slope of 1/r.

B. has a slope of - (1 + r).

The following entities issue bonds to engage in long-term borrowing except A. the federal government B. individuals C. state and local governments D. corporations

B. individuals

The concept of compound interest is best described as A. the inverse of simple interest. B. interest earned on interest. C. interest earned on an investment. D. the total amount of interest earned over the life of an investment.

B. interest earned on interest.

The managers of a firm can maximize stockholder wealth by A. taking only the highest NPV project each year. B. taking all projects with positive NPVs. C. taking all projects with NPVs greater than the present value of cash flows. D. taking all projects with NPVs greater than the cost of investment.

B. taking all projects with positive NPVs.

Which of the following types of assets are intangible? A. factories B. trademarks C. production machinery D. office equipment

B. trademarks

Which bond is more sensitive to an interest rate change? Bond A: YTM = 4% and maturity = 8 years Bond B: YTM = 3.50% and maturity = 5 years

Bond A (longer years)

Generally, a corporation is owned by its A. managers. B. managers, board of directors, and shareholders. C. shareholders. D. board of directors and shareholders

C. shareholders.

One can best describe the term structure of interest rates as the relationship between A. yields of coupon bonds and their maturity B. spot interest rates and stock prices C. spot interest rates and time D. spot interest rates and bond prices

C. spot interest rates and time

Which of the following groups are referred to as stakeholders? A. Shareholders only B. Employees, customers, and suppliers only C. Employees and customers only D. Employees, customers, shareholders, and suppliers

D. Employees, customers, shareholders, and suppliers

If you are paid $1,000 at the end of each year for the next five years, what type of cash flow did you receive? A. Uneven cash flow stream B. A perpetuity C. An annuity due D. An annuity

D. an annuity

Present value is defined as A. present cash flows compounded into the future. B. future cash flows multiplied by the factor (1 + r)t. C. inverse of future cash flows. D. future cash flows discounted to the present by an appropriate discount rate.

D. future cash flows discounted to the present by an appropriate discount rate.

A corporation, potentially, has infinite life because it A. has the same ownership and management B. has limited liability C. is closely regulated D. is a legal entity

D. is a legal entity

The following are examples of real assets: A. machinery only. B. machinery and office buildings only. C. common stock only. D. machinery, office buildings, and warehouses only

D. machinery, office buildings, and warehouses only

Which of the following assets is tangible? A. Microsoft's technical expertise B. Apple Inc.'s trademark C. Hewlett-Packard's most recent printer patent D. ExxonMobil's corporate headquarters building

ExxonMobil's corporate headquarters building

True or false. A firm's total asset value belongs entirely to shareholders.

False

True or false. A safe dollar is always worth less than a risky dollar because the rate of return on a safe investment is generally low and the rate of return on a risky investment is generally high.

False

True or false. Real assets of a corporation are claims on their financial assets.

False

You are considering investing in a retirement fund that requires you to deposit $5,000 per year, and you want to know how much the fund will be worth when you retire. What financial technique should you use to calculate this value?

Future value of an annuity

Consumption:

Individuals can adjust their preferences for consumption by borrowing or lending in the financial market. The appropriate balance between present and future consumption that each individual will choose depends on personal preferences. Nevertheless, individuals with different preferences can adjust their preferences using the financial market. Individuals desiring current consumption can borrow from future income. Meanwhile, individuals favoring future consumption can refrain from current consumption and invest in the same financial market.

Why is "maximization of shareholders' wealth" the ultimate long-term goal of the firm?

The maximization of shareholders' wealth is the ultimate goal of the firm. This is important because a company wants to increase the overall value of shares. As share prices go up in the long-run, it makes the company more desirable. Short-term profit would not be the ultimate goal because it's important to look at the big picture of a company for a maximized value. A company needs to do what is best for the owners, the shareholders, not managers. The maximized and increased wealth of the stockholders and the company's value of shares can then be used to save or spend.

Limited liability

The shareholders of a corporation cannot be held personally responsible for the debts of the corporation. This is called limited liability. Hence, a shareholder's loss is limited to the amount he or she has invested in a corporation. This is an attractive feature for investors.

True or false. A U.S. treasury "strip" is a zero-coupon bond.

True

If a bond's volatility is 5% and the yield to maturity changes by .5 percent (points), the price of the bond

changes by 2.5 percent ?

If a bond pays interest semiannually, then it pays interest

every six months

This book is mainly about

financial decisions made by corporations

A corporation

is a legal entity and has an existence of its own. Generally, large businesses are organized as corporations

The type of bond where the identities of bond owners are recorded and the coupon interest payments are sent automatically are called

registered bonds

Sequence of cash flows:

• Cash is raised by selling financial assets to investors. • Cash is invested in the firm's operation and used to purchase real assets • Cash is generated by the firm's operations. • Cash is reinvested or returned to investors.

Corporations:

• Corporations have infinite life. • Corporations have very many owners called shareholders and therefore corporations can raise funds more easily than other forms of business. • There is a separation of ownership and management that is helpful in running the corporation on a day-to-day basis. • It is relatively easy to transfer ownership in a corporation. • Corporations have limited liability.