Exam 2 Review

You hope to buy your dream car five years from now. Today, that car costs $62,500. You expect the price to increase by an average of 2.9 percent per year. How much will your dream car cost by the time you are ready to buy it? $72,103.59 $73,340.00 $66,818.02 $69,023.16 $68,666.67

$72,103.59 Explanation FV = $62,500(1.0295)FV = $72,103.59

Your grandfather left you an inheritance that will provide an annual income for the next 20 years. You will receive the first payment one year from now in the amount of $2,500. Every year after that, the payment amount will increase by 5 percent. What is your inheritance worth to you today if you can earn 7.5 percent on your investments? $30,974.92 $28,667.40 $35,612.20 $23,211.00 $37,537.88

$37,537.88 Explanation GAPV = $2,500{[1 −(1.05/1.075)^20]/(.075 − .05)} GAPV = $37,537.88

You are paying an EAR of 16.78 percent on your credit card. The interest is compounded monthly. What is the annual percentage rate on this account? 16.35% 15.75% 14.98% 13.97% 15.61%

15.61% Explanation APR = 12(1.1678^(1/12) − 1) APR = .1561, or 15.61%

What is the EAR of 18.9 percent compounded continuously? 20.80% 19.43% 19.89% 21.38% 19.06%

20.80% Explanation EAR = e^0.189 − 1 EAR = .2080, or 20.80%

The Art Gallery is notoriously known as a slow payer. The firm currently needs to borrow $25,000 and only one company will loan to them. The terms of the loan call for weekly payments of $500 at a weekly interest rate of .45 percent. What is the loan term? 42.5 weeks 45.00 weeks 56.77 weeks 50.11 weeks 43.33 weeks

56.77 weeks Explanation PVA = $25,000 = $500{[1 − (1/1.0045^t)]/.0045} t = 56.77 weeks

A new sports coupe costs $41,750 and the finance office has quoted you an APR of 7.7 compounded monthly for 36 months. What is the EAR? 7.94% 8.02% 7.81% 8.13% 7.98%

7.98% Explanation EAR = (1 + .077/12)^12 − 1 EAR = .0798, or 7.98%

The pure time value of money is known as the: interest rate factor. Fisher effect. inflation factor. term structure of interest rates. liquidity effect.

term structure of interest rates.

Syed Development issued 20-year bonds one year ago at a coupon rate of 10.2 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM is 8.2 percent, what is the current bond price? $1,098.00 $1,190.93 $1,142.16 $991.90 $985.55

$1,190.93 Explanation Bond price = $51 * ({1 − [1/(1 + .082/2)^(19*2)]}/(.082/2)) + $1,000/(1 + .082/2)^(19*2) Bond price = $1,190.93

You invested $6,500 at 6 percent simple interest. How much more could you have earned over a 10-year period if the interest had compounded annually? $930.11 $1,182.19 $1,240.51 $1,049.22 $1,201.15

$1,240.51 Explanation FVSimple = $6,500 + ($6,500)(.06)(10) FVSimple = $10,400 FVCompound = $6,500(1.0610) FVCompound = $11,640.51 Difference = $11,640.51 − 10,400 Difference = $1,240.51

Grace is retiring today and has $300,000 in her retirement savings. She expects to earn 8.5 percent per year compounded monthly. How much can she withdraw from her retirement savings each month if she plans to spend her last penny 17 years from now? $25,500.00 $2,784.88 $33,993.59 $18,793.23 $2,832.80

$2,784.88 Explanation PVA = $300,000 = C[(1 − {1/[1 + (.085/12)]^(17)(12)})/(.085/12)] C = $2,784.88

You purchased an investment that will pay you $8,000, in real dollars, per year for the next three years. Each payment will be received at the end of the period with the first payment occurring one year from today. The nominal discount rate is 8.46 percent and the inflation rate is 3.1 percent. What is the present value of these payments in real dollars? $20,447 $18,529 $20,720 $21,705 $18,811

$21,705 Explanation You need to discount real dollars with the real interest rate. r = 1.0846/1.031 − 1 r = .0520, or 5.20% PV = $8,000{[1 − (1/1.052^3)]/.052} PV = $21,705

Kris borrowed $25,000 with an interest-only, 4-year loan at 4.75 percent. What is the amount of the loan payment in Year 4 if payments are made annually? $25,296.88 $296.88 $1,187.50 $26,187.50 $7,009.40

$26,187.50 Explanation PaymentYear 2 = $25,000 + $25,000(.0475) PaymentYear 2 = $26,187.50

Today, you want to sell a $1,000 face value zero coupon bond you currently own. The bond matures in 3.5 years. How much will you receive for your bond if the market yield to maturity is currently 6.19 percent? Ignore any accrued interest. Assume semiannual compounding. $798.09 $741.08 $756.14 $807.86 $896.60

$807.86 Explanation Bond price = $1,000/(1 + .0619/2)^(3.5 × 2) Bond price = $807.86

Assume you own a violin currently valued at $64,000. If the value increases by 2.5 percent annually, how much will the violin be worth 15 years from now? $86,008.17 $92,691.08 $94,035.00 $80,013.38 $91,480.18

$92,691.08 Explanation FV = $64,000(1.02515)FV = $92,691.08

You just won the magazine sweepstakes and opted to take unending payments. The first payment will be $50,000 and will be paid one year from today. Every year thereafter, the payments will increase by 2.5 percent annually. What is the present value of your prize at a discount rate of 7.9 percent? $1,350,000.00 $1,348,409.50 $891,006.67 $925,925.93 $846,918.22

$925,925.93 Explanation GPPV = $50,000/(.079 − .025) GPPV = $925,925.93

In 1903, the winner of a competition was paid $50. In 2020, the winner's prize was $235,000. What will the winner's prize be in 2040 if the prize continues increasing at the same rate? (Do not round intermediate calculations. Round your answer to the nearest $500.) $999,000 $998,500 $996,500 $997,000 $1,000,000

$997,000 Explanation $235,000 = $50[(1 + r)^117] r = .0749, or 7.49% FV = $235,000(1.0749^20) FV = $997,000 (rounded to nearest $500)

A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond? Senior Subordinated Unsecured Callable Par value

Callable

Miles invested $5,000 ten years ago and expected to have $10,000 today. He has neither added nor withdrawn any money since his initial investment. All interest was reinvested and compounded annually. As it turns out, he only has $8,400 in his account today. Which one of the following statements must be true? He ignored the Rule of 72, which caused his account to decrease in value. He earned a lower interest rate than he expected. He did not earn any interest on interest. He earned simple interest rather than compound interest. The future value interest factor turned out to be higher than he expected.

He earned a lower interest rate than he expected.

Caroline is going to receive a award of $20,000 six years from now. Jiexin is going to receive an award of $20,000 nine years from now. Which one of the following statements is correct if both individuals apply a discount rate of 7 percent? In future dollars, Jiexin's award is worth more than Caroline's award. Twenty years from now, the value of Caroline's award will equal the value of Jiexin's award. The present values of Caroline's and Jiexin's awards are equal. Jiexin's award is worth more today than Caroline's award. In today's dollars, Caroline's award is worth more than Jiexin's.

In today's dollars, Caroline's award is worth more than Jiexin's.

Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond? Real rate Current rate Nominal rate Risk-free rate Realized rate

Real rate

Which one of the following statements concerning bond ratings is correct? A "fallen angel" is a term applied to all "junk" bonds. Investment grade bonds are rated BB or higher by Standard & Poor's. Bond ratings assess both interest rate risk and default risk. Split-rated bonds are called crossover bonds. The highest rating issued by Moody's is AAA.

Split-rated bonds are called crossover bonds.

A note is generally defined as: an unsecured bond with an initial maturity of 10 years or less. any bond secured by a blanket mortgage. any bond maturing in 10 years or more. a secured bond that initially matures in less than 10 years. a secured bond with an initial maturity of 10 years or more.

an unsecured bond with an initial maturity of 10 years or less.

Andrew just calculated the present value of a $15,000 bonus he will receive next year. The interest rate he used in his calculation is referred to as the: compound rate. simple rate. current yield. discount rate. Correct effective rate.

discount rate.

Madelyn is calculating the present value of a bonus she will receive next year. The process she is using is called: accumulating. reducing. discounting. Correct compounding. growth analysis.

discounting.

A loan that calls for periodic interest payments and a lump sum principal payment is referred to as a(n) ____ loan. interest-only modified pure discount balloon amortized

interest-only

The current yield is defined as the annual interest on a bond divided by the: coupon rate. par value. call price. market price. face value.

market price.

Hayley won a lottery and will receive $1,000 each year for the next 30 years. The current value of these winnings is called the: simple amount. compounded value. present value. single amount. future value.

present value.

If a borrower receives money today and must repay the loan in a single lump sum on a future date, the loan is called a(n) ________ loan. interest-only balloon pure discount amortized continuous

pure discount

What is the future value in 60 years of $7,440 invested today at 9 percent interest, compounded annually? $91,006 $38,256 $1,309,673 $1,314,038 $14,469,253

$1,309,673 Explanation FV = $7,440(1 + .0960) FV = $1,309,673

You borrowed $185,000 for 30 years to buy a house. The interest rate is 4.35 percent compounded monthly. If you pay all of your monthly payments as agreed, how much total interest will you pay on this mortgage? (Round the monthly payment to the nearest whole cent.) $147,027 $146,542 $154,319 $150,408 $141,406

$146,542 Explanation PVA = $185,000 = C[(1 − {1/[1 + (.0435/12)]^(30)(12)})/(.0435/12)] C = $920.95 Total interest = $920.95(30)(12) − 185,000 Total interest = $146,542

A newly issued 10-year, $1,000 face value zero coupon bond just sold for $311.05. What is the implicit interest, in dollars, for the first year of the bond's life? Assume semiannual compounding. $47.72 $38.53 $45.89 $57.63 $41.47

$38.53 Explanation Bond price0 = $311.05 = $1,000/(1 + r/2)^(10 × 2) r = .120257, or 12.0257%

You are considering two savings options. Both options offer a rate of return of 8.3 percent. The first option is to save $1,500, $1,250, and $6,400 at the end of each year for the next three years, respectively. The other option is to save one lump sum amount today. You want to have the same balance in your savings account at the end of the three years, regardless of the savings method you select. If you select the lump sum method, how much do you need to save today? $7,489 $11,428 $8,449 $7,203 $11,623

$7,489 Explanation PV = $1,500/1.083 + $1,250/1.083^2 + $6,400/1.083^3 PV = $7,489

Aidan deposited $8,500 in an account today. If the account earns 8.5 percent per year, compounded annually, how many years will it take for the account to reach a balance of $138,720? 6.13 years 29.78 years 16.32 years 46.55 years 34.23 years

34.23 years Explanation: $138,720 = $8,500*(1.085^t) t = 34.23 years

Suppose the real rate is 3.45 percent and the inflation rate is 2.2 percent. What rate would you expect to earn on a Treasury bill? 6.56% 5.73% 7.75% 3.30% 1.25%

5.73% Explanation R = [1.0345(1.022)] − 1 R = .0573, or 5.73%

Coronel Corporation wants to issue new 20-year bonds. The company currently has 8.5 percent bonds on the market that sell for $994, make semiannual payments, and mature in seven years. What should the coupon rate be on the new bonds if the firm wants to sell them at par? 8.62% 8.75% 8.87% 9.23% 8.41%

8.62% Explanation $994 = $42.50({1 − [1/(1 + r)^(7 × 2)]}/r) + $1,000/(1 + r)^(7 × 2) To solve for r, use trial-and-error, a financial calculator, or a computer. YTM = 2(4.308%) YTM = 8.62%

Assume you deposited $6,000 into a retirement savings account today. The account will earn 8 percent interest per year, compounded annually. You will not withdraw any principal or interest until you retire in 48 years. Which one of the following statements is correct? The present value of this investment is equal to $6,000. The future value of this amount is equal to $6,000 × (1 + 48).08. The total amount of interest you will earn will equal $6,000 × .08 × 48. The interest you earn in Year 7 will equal the interest you earn in Year 14. The interest amount you earn will double in value every year.

The present value of this investment is equal to $6,000.

Which one of the following statements correctly defines a time value of money relationship? An increase in a positive discount rate increases the present value. Time and future values are inversely related, all else held constant. An increase in time increases the future value given a zero rate of interest. Interest rates and time are positively related, all else held constant. Time and present value are inversely related, all else held constant.

Time and present value are inversely related, all else held constant.

You have been purchasing $12,000 worth of stock annually for the past eight years and now have a portfolio valued at $87,881. What is your annual rate of return? 3.29% 2.54% −4.32% 4.32% −2.54%

−2.54% Explanation FVA = $87,881 = $12,000{[(1 + r)8 − 1]/r} r = −.0254, or −2.54%