Chapter 5 & 6 - Finance

The current value of cash flows discounted at the appropriate discount rate

Present value

How do you solve for compound interest/future value?

Principle (1+rate) Nth power Same as future value

How do you solve for simple interest?

Principle + (Principle + Rate + Number of periods) P+(PIN)

What is the most simplest form of loan?

Pure discount loan

The borrower receives money today and repays a single lump sum at some time in the future The borrower pays interest each period and to repay the entire principal at some point in the future

Pure discount loan/interest-only loan

The number of years it takes for a certain amount to double in value

Rule of 72 (72/rate of interest)

Interest earned only on the original principle amount invested

Simple interest

The interest rate expressed in terms of the interest payment made each period.

Stated interest rate

Borrower pays interest each period and to repay the entire principle at some point in the future

interest only loan(s)

Steve invested $100 two years ago at 10 percent interest. The first year, he earned $10 interest on his $100 investment. He reinvested the $10. The second year, he earned $11 interest on his $110 investment. The extra $1 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

Which one of the following variables is the exponent in the present value formula? A) present value B) future value C) interest rate D) time E) There is no exponent in the present value formula

D

When does the effective annual rate equal the annual percentage rate?

when interest is compounded annually

*** 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 amount D) discounted value E) invested principal

A

Beatrice invests $1,280 in an account that pays 5 percent simple interest. How much more could she have earned over a 6-year period if the interest had been compounded annually? A) $51.32 B) $307.93 C) $36.45 D) $30.37 E) $21.16

A

You have just deposited $8,500 into an account that promises to pay you an annual interest rate of 6 percent each year for the next 6 years. You will leave the money invested in the account and 10 years from today, you need to have $19,320 in the account. What annual interest rate must you earn over the last 4 years to accomplish this goal? A) 12.51% B) 11.55% C) 11.37% D) 14.07% E) 10.01%

A

Your sister just deposited $5,000 into an investment account. She believes that she will earn an annual return of 8.7 percent for the next 5 years. You believe that you will only be able to earn an annual return of 7.8 percent over the same period. How much more must you deposit today in order to have the same amount as your sister in 5 years? A) $212.23 B) $618.79 C) $164.90 D) $198.09 E) $226.38

A

Which type of compounding has the lowest effective annual rate?

Annual

What is the most common interest rate quoted?

Annual percentage rate

An annuity for which the cash flows occur at the beginning of the period

Annuity due

Christina invested $3,000 five years ago and earns 2 percent annual interest. 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: A) simplifying. B) compounding. C) aggregating. D) accumulating. E) discounting.

B

Your grandmother has promised to give you $10,000 when you graduate from college. If you speed up your graduation by one year and graduate two years from now rather than the expected three years, the present value of this gift will: A) remain constant. B) increase. C) decrease. D) equal $10,000. E) be greater than $10,000.

B

Loan characterized by an amortization term that is longer than the loan term. Because the loan balance will not be zero at the end of the loan term, this kind of payment is necessary to pay off the remaining loan balance in full.

Balloon loan

Renee invested $2,000 six years ago at 4.5 percent interest. She spends all of her interest earnings immediately 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

The process of determining the present value of future cash flows in order to know their value today is referred to as: A) compound interest valuation. B) interest on interest valuation. C) discounted cash flow valuation. D) future value interest factoring. E) complex factoring.

C

Interest earned on both the initial principle and the interest reinvested from prior periods

Compound interest

the process of accumulating interest on an investment over time to earn more interest

Compounding

To calculate the present value of some future amount

Discount

Steve just computed the present value of a $10,000 bonus he will receive next year. The interest rate he used in his computation is referred to as the: A) current yield. B) effective rate. C) compound rate. D) simple rate. E) discount rate.

E

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 that neither Sue nor Neal has withdrawn any money from their accounts? 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, then they will have equal amounts of savings E) Sue will have more money than Neal as long as they retire at the same time

E

The interest rate expressed as if it were compounded once per year (interest only)

Effective annual rate

The amount an investment is worth after one or more periods

Future value

If you're trying to save for retirement and you decide to retire later, what would happen? The quiz: Which of the following would reduce the amount you earn today?

Higher interest rate or put in less now

How can you increase future value? How do you increase present value?

Increase rate or number of periods, lower rate or number of periods

What is the relationship between future and present value?

Inversely related/reciprocal

A level stream of cash flows for a fixed period of time, occurs at the end of the period

Ordinary annuity

An annuity in which the cash flows continue forever

Perpetuity