FIN303 Chp 5-7

Kathleen just received a bonus from EG. She is excited because her dad started his career with EG. If her bonus of $300,000 is equivalent to the bonus paid to her dad 10 years ago, how much was her dad's bonus?

$206,608

You are starting college this month, and your favorite aunt has agreed to give you $4,000 at the end of each of your four years and you can save $8,000 at the end of each year for the first two years after you graduate. If all of these amounts are invested at 14%, how much will you have to start graduate school, six years from now?

$42,702

Cavincare has 50 years remaining on a service contract with Martin, Inc. Today, Martin paid $120,000 for services received last year and the annual payment increases by 2.5% each year. The firm's required rate of return is 15%. What is the value of the contract to Cavincare?

$980,879

Based on the table below, what is the expected return of the stock?

12.4%

Boretti has $400,000 in a stock fund. The fund pays a 10% return, compounded annually. If he does not make another deposit into the account, how long will it take for the account to increase to $2 million?

16.89 years

An investment pays 18 percent interest compounded quarterly. What is the effective annual interest rate?

19.3%

The expected return on Bevo stock is 12.6 percent. If the expected return on the market is 10 percent and the beta for Bevo is 1.4, then what is the risk-free rate?

3.5%

Use the following table to calculate the expected return for the asset. Return 12% 15% 10% Probability 50% 7% 35%

9.3%

Which of the following equations is correct?

Annuity due value = Ordinary value × (1+i)

An investor will choose between Asset Q with an expected return of 6.5% and a standard deviation of 5.5%, Asset U with an expected return of 8.8% and a standard deviation of 5.5%, and Asset B with an expected return of 8.8% and a standard deviation of 6.5%. Which one should the investor prefer?

Asset U

Why do earnings from compounding drive much of the return earned on a long-term investment?

Because longer the investment period, the greater the proportion of total earnings from interest earned on interest

If the interest rate per year and the number of years involved remain the same, the total amount of interest earned on an investment will remain the same irrespective of the frequency of compounding.

False

The larger the variance, the smaller the standard deviation

False

Total holding period return is the dollar gain (or loss) from purchasing an asset and selling it later.

False

The total amount of interest earned on an investment depends on the frequency of compounding, as well as interest rate per year and the number of years involved

If the interest rate per year and the number of years involved remain the same, the total amount of interest earned on an investment will remain the same irrespective of the frequency of compounding

Which of the following interest rates is annualized using simple interest?

The annual percentage rate (APR)

Generally, the future value of an investment will be greater if

The investment is compounded at a higher rate of return.

The present value of future cash flows

The present value of future cash flows increases as the discount rate decreases

Total compound interest is the

Total compound interest is the sum of simple interest and interest on interest

Based upon annual total returns from 1926-2006, the small-size stock portfolio in the US had the largest average return and the highest standard deviation as well

True

Under which of the following discounting methods will the present value of an investment be the highest, assuming the same annual interest rate?

Yearly

The correlation between the return on two assets _____

all of the above.

Time lines

an important tool for analyzing problems that involve cash flows over time

The simple interest rate charged per period multiplied by the number of payment periods per year gives the

annual percentage rate

A typical present value of an annuity formula assumes that

cash flows occur at the end of each period.

Based on the CAPM, the relationship between the expected return of an asset and its systematic risk is _____

linear

The future value of an annuity is typically used when analyzing

retirement plans.

A modern day example of a perpetuity is a

share of preferred stock

Investors care only about _____

systematic risk

The two components of total risk associated with an investment are _____

systematic risk and diversifiable risk

When choosing between two investments

that have the same level of risk, investors prefer the investment with the higher return.

Covariance measures _____

the absolute relationship between the returns of each pair of assets

The Capital Asset Pricing Model (CAPM) measures

the expected rate of return of an asset.