UNIT 4: Interest Rates, TVM, and Risk and Return Quiz

Which answer is not a cost to the investor that is included in the calculation of an investment's interest rate? A) Brokerage commissions and fees B) Inflation C) Opportunity Cost D) Risk of a bad investment

A) Brokerage commissions and fees *Brokerage commissions are an actual cost to investor but are not priced by the seller.

What is the present value of $100,000 that will be received 5 years from today if you face a 10% compound interest rate every year (rounded up to the nearest dollar)? A) $82,092 B) $62,092 C) $52,092 D) $72,092

B) $62,092 *PV = $100,000/(1.105) = $62,092 Using Calculator: N = 5, I/Y = 10, FV = 100,000. [CPT] PV = $62,092.

You are considering investing in the common stock of a major US Corporation. Which answer is an example of systematic risk? A) Risk resulting from general unrest in the company's labor force B) Risk resulting from a general decline in the US stock markets C) Risk related to the possibility of foreign expropriation of the company's property C) Risk related to an impending lawsuit against the company

B) Risk resulting from a general decline in the US stock markets *This illustrates a risk exposure that affects all companies in the market and is thus an example of systematic risk.

Which statement accurately describes systematic risk? A) By diversifying your stock portfolio, you can minimize systematic risk. B) Systematic risk is what provides a stock's "risk premium." C) Systematic risk is uncertainty associated with a company or industry in which you invest. D) An example of a systematic risk is if you own stock in a company that has liquidity problems.

B) Systematic risk is what provides a stock's "risk premium." *Systematic risk is priced in the market since it is undiversifiable.

Which answer is not a factor that influences market interest rates? A) Alternative investments B) Inflationary expectations C) Stock market activity D) Deferred consumption

C) Stock market activity *This is a factor that does not influence market interest rates.

You own a perpetuity that pays $1000 in the first year. It has a 5% annual interest rate and a 2% annual growth rate. What is the present value of the perpetuity? A) $20,000 B) $14,286 C) $33,333 D) $50,000

C) $33,333 *PVGP = A1/(i - g) = $1000/(0.05 - 0.02) = $33,333.

You expect to receive a payment of $1 million in a year. The annual interest rate is 5%. What is the present value of the future payment? A) $995,025 B) $105,000 C) $952,381 D) $666,667

C) $952,381 *PV = $1 million/(1.05) = $952,381 Using Calculator: N = 1, I/Y = 5, FV = $1 million. [CPT] PV = $952,381

Of the following car financing options, which one would you prefer while assuming that you prefer paying the least amount of dollars and that you face a 10% annual compound interest rate on all your financial decisions? A) A payment $10,000 today and another of $10,000 in one year from today. B) A lump-sum payment of $20,000 today only. C) A lump-sum payment of $20,000 in two years from today. D) A lump-sum payment of $19,000 today only.

C) A lump-sum payment of $20,000 in two years from today. *PV = $20,000/(1.102) = $16,529 gives the smallest payment in today's value. Using Calculator: N = 2, I/Y = 10, FV = 20,000. [CPT] PV = $16,529.

Which prediction based on a description of the yield curve is not correct? A) An inverted yield curve suggests that interest rates will be dramatically cut. B) A flat yield curve suggest that interest rates will be cut. C) A normal yield curve suggests that interest rates will remain the same in the future. D) A normal yield curve suggests that interest rates will be raised in the future.

C) A normal yield curve suggests that interest rates will remain the same in the future. *Normal yield curves suggest that interest rates rise over time.

Which of the following describes the relationship between present value and future value? A) The higher the interest rate, the higher the present value and the lower the future value. B) The more time that passes, the higher the present value and the lower the future value. C) When one increases, the other increases, assuming all variables are constant. D) When present value increases, the future value decreases, assuming all variables are constant.

C) When one increases, the other increases, assuming all variables are constant. *A higher cash flow today would result in a higher amount in the future and vice versa.

Which option is an adequate method to reduce an investor's risk through diversification? A) Invest in the common stocks of the two companies that have performed the best in the last 5 years. B) Invest in a small pool of stocks from companies in the same industry. C) Invest in a start-up business that has a broad ownership among a large number of investors. D) Invest in a broad pool of US and international stocks and bonds.

D) Invest in a broad pool of US and international stocks and bonds. *Risk can be diversified away by investing in a broad pool of assets.

What type of risk can an investor reduce through the process of diversification? A) Systematic risk only B) Uncertainty C) All risk can be reduced D) Unsystematic risk

D) Unsystematic risk *Unsystematic risk can be reduced through diversification.

The risk that remains after an investor has extensively diversified his portfolio is primarily....

systematic risk *Systematic risk is the portion of risk in a portfolio that cannot be diversified away.