FIN 3403- Chapter 5

Art invested $100 two years ago at 8 percent interest. The first year, he earned $8 interest on his $100 investment. He reinvested the $8. The second year, he earned $8.64 interest on his $108 investment. The extra $.64 he earned in interest the second year is referred to as: A. Free interest. B. Bonus income. C. Simple interest. D. Interest on interest. E. Present value interest.

D. Interest on interest.

Which one of the following variables is the exponent in the present value formula? A. Present value B. Future value C. Interest rate D. Number of time periods E. There is no exponent in the present value formula.

D. Number of time periods

Interest earned on both the initial principal and the interest reinvested from prior periods is called: A. Free interest. B. Dual interest. C. Simple interest. D. Interest on interest. E. Compound interest.

E. Compound interest.

Steve just computed the present value of a $10,000 bonus he will receive in the future. The interest rate he used in this process is referred to as which one of the following? A. Current yield. B. Effective rate. C. Compound rate. D. Simple rate. . E. Discount rate.

E. Discount rate.

You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now? A. Future value. B. Present value. C. Principal amounts. D. Discounted value. E. Invested principal.

A. Future value.

Which of these will increase the present value of an amount to be received sometime in the future? A. Increase in the time until the amount is received. B. Increase in the discount rate. C. Decrease in the future value. D. Decrease in the interest rate. E. Decrease in both the future value and the number of time periods.

D. Decrease in the interest rate.

Terry is calculating the present value of a bonus he will receive next year. The process he is using is called: A. Growth analysis. B. Discounting. C. Accumulating. D. Compounding. E. Reducing.

B. Discounting.

Renee invested $2,000 six years ago at 4.5 percent interest. She spends her earnings as soon as she earns any interest so she only receives interest on her initial $2,000 investment. Which type of interest is she earning? A. Free interest. B. Complex interest. C. Simple interest. D. Interest on interest. E. Compound interest.

C. Simple interest.

Which one of the following will produce the lowest present value interest factor? A. 6 percent interest for 5years . B. 8 percent interest for 5 years. C. 6 percent interest for 10 years. D. 8 percent interest for 5 years. E. 8 percent interest for 10 years.

E. 8 percent interest for 10 years.

Christina invested $3,000 five years ago and earns 2 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following? A. Simplifying. B. Compounding. C. Aggregation. D. Accumulation. E. Discounting.

B. Compounding.

Phillippe invested $1,000 10 years ago and expected to have $1,800 today. He has not added or withdrawn any money from this account since his initial investment. All interest was reinvested in the account. As it turns out, he only has $1,680 in his account today. Which one of the following must be true? A. He earned simple interest rather than compound interest. B. He earned a lower interest rate than he expected. C. He did not earn any interest on interest as he expected. D. He ignored the Rule of 72 which caused his account to decrease in value. E. The future value interest factor turned out to be higher than he expected.

B. He earned a lower interest rate than he expected.

Your grandmother has promised to give you $10,000 when you graduate from college. She is expecting you to graduate three years from now. What happens to the present value of this gift if you speed up your graduation by one year and graduate two years from now? A. Remains constant. B. Increases. C. Decreases. D. Becomes negative. E. Cannot be determined from the information provided.

B. Increases.

Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true? A. Barb will earn more interest the first year than Andy will. B. Andy will earn more interest in year three than Barb will. C. Barb will earn more interest the second year than Andy. D. After five years, Andy and Barb will both have earned the same amount of interest. E. Andy will earn compound interest.

C. Barb will earn more interest the second year than Andy.

The process of determining the present value of future cash flows in order to know their worth today is referred to as: A. Compound interest valuation. B. Interest on interest computation. C. Discounted cash flow valuation. D. Present value interest factoring. E. Complex factoring.

C. Discounted cash flow valuation.

You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You will earn 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire? I. Invest in a different account paying a higher rate of interest. II. Invest in a different account paying a lower rate of interest. III. Retire later. IV. Retire sooner. A. I only. B. II only. C. I and III only. D. I and IV only. E. II and III only.

C. I and III only.

Luis is going to receive $20,000 six years from now. Soo Lee is going to receive $20,000 nine years from now. Which one of the following statements is correct if both Luis and Soo Lee apply a 7 percent discount rate to these amounts? A. The present values of Luis and Soo Lee's money are equal. B. In future dollars, Soo Lee's money is worth more than Luis's money. C. In today's dollars, Luis's money is worth more than Soo Lee's. D. Twenty years from now, the value of Luis's money will be equal to the value of Soo Lee's money. E. Soo Lee's money is worth more than Luis's money given the 7 percent discount rate.

C. In today's dollars, Luis's money is worth more than Soo Lee's.

Kurt won a lottery and will receive $1,000 a year for the next 50 years. The value of his winnings today discounted at his discount rate is called which one of the following? A. Single amount. B. Future value. C. Present value. D. Simple amount. E. Compounded value.

C. Present value.

Samantha opened a savings account this morning. Her money will earn 3.5 percent interest, compounded annually. After four years, her savings account will be worth $5,000. Assume she will not make any withdrawals. Given this, which one of the following statements is true? A. Samantha deposited more than $5,000 this morning. B. Samantha is earning simple interest on her savings. C. Samantha could have deposited less money today and still had $5,000 in four years if she could have earned a higher rate of interest. D. The present value of Samantha's account is $5,000. E. Samantha could earn more interest on this account if she withdrew her interest earnings each year.

C. Samantha could have deposited less money today and still had $5,000 in four years if she could have earned a higher rate of interest.

This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in 40 years. Which one of the following statements is correct? A. The interest you earn 6 years from now will equal the interest you earn t10 years from now. B. The interest amount you earn will double in value every year. C. The total amount of interest you will earn will equal $1,000 .06 40. D. The present value of this investment is equal to $1,000. E. The future value of this amount is equal to $1,000 (1 + 40).06.

D. The present value of this investment is equal to $1,000.

Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue and Neal retire at age 60. Which one of the following statements is correct assuming neither Sue nor Neal withdraw any money from their accounts prior to retiring? A. Sue will have less money when she retires than Neal. B. Neal will earn more interest on interest than Sue. C. Neal will earn more compound interest than Sue. D. If both Sue and Neal wait to age 70 to retire, they will have equal amounts of savings. E. Sue will have more money than Neal at age 60.

E. Sue will have more money than Neal at age 60.

What is the relationship between present value and future value interest factors? A. The present value and future value factors are equal to each other. B. The present value factor is the exponent of the future value factor. C. The future value factor is the exponent of the present value factor. D. The factors are reciprocals of each other. E. There is no relationship between these two factors.

E. There is no relationship between these two factors.