Finance - Chapter 5

The annual rate of return is referred to as the ________.

Discount Rate

The rate of interest agreed upon contractually charged by a lender or promised by a borrower is the ________ interest rate.

Nominal

An interest rate or a required rate of return represents the cost of money.

True

The annuity due is an amount that occurs at the beginning of each period.

True

When computing the number of deposits needed to accumulate a future sum, it will take longer if the interest rates are higher, holding the future value and deposit size constant.

False

In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion of each payment declines over the life of the loan.

True

Nominal rate of interest is equal to the sum of the real rate of interest plus an inflation premium plus a risk premium.

True

Everything else being equal, the higher the interest rate, the higher the future value.

True

Everything else being equal, the longer the period of time, the lower the present value.

True

Risk-free rate of interest is equal to the sum of the real rate of interest plus an inflation premium.

True

When computing an interest or growth rate, the rate will decrease with an increase in future value, holding present value and the number of periods constant.

False

When computing an interest or growth rate, the rate will increase with a decrease in future value, holding present value and the number of periods constant.

False

For a given positive interest rate, the future value of $100 increases with the passage of time. Thus, the longer the period of time, the greater the future value.

True

Future value increases with increases in the interest rate or the period of time funds are left on deposit.

True

The annual percentage rate (APR) is the nominal rate of interest, found by multiplying the periodic rate by the number of periods in one year.

True

The annual percentage yield (APY) is the effective rate of interest that must be disclosed to customers by banks on their savings products as a result of "truth in savings laws."

True

The effective annual rate increases with increasing compounding frequency.

True

The effective rate of interest differs from the nominal rate of interest in that it reflects the impact of compounding frequency.

True

The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity for interest rates greater than zero.

True

The nominal and effective rates are equivalent for annual compounding.

True

When computing an interest or growth rate, the rate will increase with an increase in future value, holding present value and the number of periods constant.

True

When computing the number of deposits needed to accumulate to a future sum, it will take longer if the interest rate decreases, holding the future value and deposit size constant.

True

The nominal (stated) annual rate is the rate of interest actually paid or earned.

False

The nominal rate of interest on a bond is 7% and an inflation premium of 3%. This results in a real rate of interest of 4% on the bond.

False

In comparing an ordinary annuity and an annuity due, which of the following is true? A) The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity. B) The future value of an ordinary annuity is always greater than the future value of an otherwise identical annuity due. C) The future value of an annuity due is always less than the future value of an otherwise identical ordinary annuity, since one less payment is received with an annuity due. D) All things being equal, one would prefer to receive an ordinary annuity compared to an annuity due.

A) The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity.

If the present value of a perpetual income stream is increasing, the discount rate must be _________

B) Decreasing

Which of the following is true of annuities? A) An ordinary annuity is an equal payment paid or received at the beginning of each period. B) An annuity due is a payment paid or received at the beginning of each period that increases by an equal amount each period. C) An annuity due is an equal stream of cash flows paid or received at the beginning of each period. D) An ordinary annuity is an equal payment paid or received at the end of each period that increases by an equal amount each period.

C) An annuity due is an equal stream of cash flows paid or received at the beginning of each period.

________ is the amount earned on a deposit that has become the part of the principal at the end of a specified time period.

Compound Interest

The rate of interest actually paid or earned, also called the annual percentage rate (APR), is the ________ interest rate.

Effective

A nominal rate of interest is equal to the sum of the real rate of interest plus the risk free rate of interest.

False

A real rate of interest is the compensation paid by the borrower of funds to the lender.

False

An ordinary annuity is an annuity in which cash flows occur at the beginning of each period.

False

Everything else being equal, the higher the discount rate, the higher the present value.

False

For any interest rate and for any period of time, the more frequently interest is compounded, the greater the amount of money that has to be invested today in order to accumulate a given future amount.

False

Future value is the value of a future amount at the present time, found by applying compound interest over a specified period of time.

False

In general, with an amortized loan, the payment amount grows over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion declines over the life of the loan.

False

In general, with an amortized loan, the payment amount remains constant over the life of the loan, both the principal portion of and the interest portion declines over the life of the loan.

False

In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment declines over the life of the loan, and the interest portion of each payment grows over the life of the loan.

False

Longer the maturity of a Treasury security, the smaller the interest rate risk.

False

Since individuals are always confronted with opportunities to earn positive rates of return on their funds, the timing of cash flows does not have any significant economic consequences.

False

The effective rate of interest and compounding frequency are inversely related.

False

The effective rate of interest is the contractual rate of interest charged by a lender or promised by a borrower.

False

The greater the interest rate and the longer the period of time, the higher the present value.

False

Time value of money is based on the belief that a dollar that will be received at some future date is worth more than a dollar today.

False

The future value of a dollar _______ as the interest rate increases and ______ the further in the future an initial deposit is to be received.

Increases; Increases

A(n) ________ is an annuity with an infinite life making continual annual payments.

Perpetuity

The amount of money that would have to be invested today at a given interest rate over a specified period in order to equal a future amount is called ________.

Present Value

The time value concept/calculation used in amortizing a loan is ________.

Present value of an annuity