FIN TEST 2 CH 5&6
7) The real rate is 1.25% and inflation is 5.25%. What is the approximate nominal rate? A) 6.50% B) 5.25% C) 3.25% D) 1.25%
A) 6.50% Explanation: Roughly speaking, the nominal rate is the real rate plus inflation. Thus, the nominal rate is 1.25% plus 5.25% equals 6.50%.
6) You just bought a car and took out a loan for $30,000 and are scheduled to make monthly payments for 6 years at an annual rate of 3.9% APR. Suppose you add $132.01 each month to the contracted monthly car payment. This extra amount is applied to the principal. How long will it take you to pay off your loan of $30,000? Use a calculator to determine your answer. A) It will take just over 54 months. B) It will take just over 45 months. C) It will take just over 38 months. D) It will take just over 30 months.
A) It will take just over 54 months. Explanation: First, determine the original payment MODE = END; N = 72; PV = -30,000; I = 3.9/12; FV = 0; PMT = ? = 467.99 Next add in the additional payment = 467.99+132.01 = 600.00
14) You just bought a car and took out a loan for $30,000 and are scheduled to make monthly payments for 6 years at an annual rate of 3.9% APR. Suppose you add $132.01 each month to the contracted monthly car payment. This extra amount is applied to the principal. How long will it take you to pay off your loan of $30,000? Use a calculator to determine your answer. A) It will take just over 54 months. B) It will take just over 45 months. C) It will take just over 38 months. D) It will take just over 30 months.
A) It will take just over 54 months. Explanation: First, determine the original payment MODE = END; PV = -30,000; N = 72; I = 3.9/12; FV = 0; PMT = ? = 467.99 Next add in the additional payment = 467.99+132.01 = 600.00 Solve again MODE = END; PV = -30,000; N = 72; I = 3.9/12; FV = 0; PMT = 600; N = ? = 54.65
17) Which of the statements below is FALSE? A) No part of the default premium has to do with the frequency of default by the borrower. B) For the home loan, the collateral (the house) is an asset that will increase in value over time (in general) compared to a car loan where the collateral (the car) decreases in value over time. C) With a house, the potential loss due to default is less than a car because the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan. D) A personal credit card essentially has no collateral so the potential loss is even higher if the customer defaults on his or her credit card payments.
A) No part of the default premium has to do with the frequency of default by the borrower. Explanation: A PART of the default premium has to do with the frequency of default by the borrower.
20) James is a rational investor wishing to maximize his return over a 20-year period. The current yield curve is inverted with one-year rates at 5.00% and 20-year rates at 3.50%. James will invest in the lower-rate 20-year bonds if ________. A) he thinks rates will fall in the future and locking in long-term rates today may provide the highest long-run average return B) he thinks rates will rise in the future and locking in long-term rates today may provide the lowest long-run average return C) he thinks rates will remain flat at 5% in the future and locking in long-term rates today will prevent him from appearing greedy to those without this investment opportunity D) he thinks rates will rise in the future and locking in long-term rates today may provide the highest long-run average return
A) he thinks rates will fall in the future and locking in long-term rates today may provide the highest long-run average return
5) Assume you just bought a new car and now have a car loan to repay. The amount of the principal is $22,000, the loan is at 5.9% APR, and the monthly payments are spread out over 6 years. What is the loan payment? Use a calculator to determine your answer. A) $305.56 B) $363.57 C) $331.14 D) $297.70
B) $363.57 Explanation: MODE = END; N = 72; PV = -22,000; I = 5.9/12; FV = 0; PMT = 363.57
13) You just entered into a $150,000 30-year home mortgage at an annual interest rate of 4.25% making monthly payments of $737.91. Suppose you add an additional payment of $295.97 each month to the $737.91 house payment making your total monthly payments equal to $1,033.88. This extra amount is applied against the principal of the original loan. How long will it take you to pay off your loan of $150,000? Use a calculator to determine your answer. A) It will take about 186 months. B) It will take about 206 months. C) It will take about 216 months. D) It will take about 265 months.
B) It will take about 206 months. Explanation: MODE = END; PV = -150,000; I = 4.25/12; PMT = 1,033.88; FV = 0; N = ? = 204
10) Kenna invests $5,000 today, compounded monthly, with an annual interest rate of 8.52%. What amount of interest will she earn in one year? A) $334.04 B) $5,443.04 C) $443.04 D) $5,334.04
C) $443.04 Explanation: PV = -$5,000 PMT = 0, I=8.52; N = 12; FV = ? = $5,443.04 Interest earned = FV - PV = $5,443.04 - $5,000 = $443.04.
4) Suppose that over the life of the loan, the total interest expense for a monthly loan is $17,000, while the total interest payment for an annual loan is $19,000. Which of the below statements is FALSE? A) The difference reflects the reduction of the principal each month versus the annual reduction of the principal. B) The more frequent the payment, the lower the total interest expense over the life of the loan, even though the effective rate of the loan is higher. C) Reducing principal at a slower pace reduces the overall interest paid on a loan. D) Reducing principal at a slower pace increases the overall interest paid on a loan.
C) Reducing principal at a slower pace reduces the overall interest paid on a loan.
11) What is the EAR if the APR is 10.52% and compounding is daily? A) Slightly above 10.09% B) Slightly below 11.09% C) Slightly above 11.09% D) Over 11.25%
C) Slightly above 11.09% Explanation: EAR = [(1 + APR/m)m] -1 = [(1 + 0.1052/365)365] -1 = 11.0916%.
2) Which of the following statements is FALSE if you increase your monthly payment above the required loan payment? A) The extra portion of the payment goes to the principal. B) You can significantly decrease the number of payments needed to pay off the loan. C) The extra portion of the payment increases the principal. D) Besides lowering the principal, you can significantly reduce the number of payments needed to pay off the loan.
C) The extra portion of the payment increases the principal. Explanation: If you increase your monthly payment above the required loan payment, then the additional portion of the payment goes to DECREASING the principal. But the important fact to note is that an extra payment above the required annuity can significantly reduce the number of payments needed to pay off the loan.
9) Which of the statements below is FALSE? A) A part of the default premium has to do with the frequency of default by the borrower. B) For the home loan, the collateral (the house) is an asset that will increase in value over time (in general), compared with a car loan in which the collateral (the car) decreases in value over time. C) With a car, the potential loss due to default is less than a house because the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan. D) A personal credit card essentially has no collateral, so the potential loss is even higher if the customer defaults on his or her credit card payments.
C) With a car, the potential loss due to default is less than a house because the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan. Explanation: With a HOUSE, the potential loss due to default is less than a car because the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan.
12) Assume you just bought a new boat and now have a boat loan to repay. The amount of the principal is $68,000, the loan is at 6.75% APR, and the monthly payments are spread out over 7 years. What is the loan payment? Use a calculator to determine your answer. A) $1,225.36 B) $1,206.58 C) $809.52 D) $1,081.01
D) $1,081.01 Explanation: MODE = END; PV = -68,000; N = 84; I = 6.75/12; FV = 0; PMT = ? = 1,018.01
15) Assume that you are willing to postpone consumption of $1,000 today and buy a certificate of deposit (CD) at your local bank with the $1,000. Holding the CD for one year provides you with an 8% reward for saving or postponing consumption. This reward for postponing consumption implies that at the end of the year you will have how much more money for spending? A) $79.50 B) $79.75 C) $79.90 D) $80.00
D) $80.00 Explanation: We take 8% times $1,000 and get $80.00 more for spending.
16) Nancy is seeking to expand her rare stamp collection. Each year, rare stamps increase in price at a three percent rate. She believes that if she invests her money for one year, she should be able to buy 16 stamps for what 15 stamps would cost today. What is the approximate nominal rate necessary to compensate for waiting and to cover inflation? A) 3.00% B) 3.67% C) 6.67% D) 9.67%
D) 9.67% Explanation: The inflation rate is 3.00%. The real interest rate or reward is given by (FV/PV)^1/n -1 where FV = 16, PV = 15 and n = 1. We have: real interest rate or reward = (16/15)1/1 -1=0.0667 or 6.67%. Nominal rate = real rate + inflation = 3.00% + 6.67% = 9.67%, which is the rate necessary to compensate her for waiting and to cover inflation.
1) Which of the following statements is FALSE? A) The APR can be referred to as a promised annual percentage rate. B) Although an APR is quoted on an annual basis, interest can be paid quarterly. C) The period in which interest is applied or the frequency of times interest is added to an account each year is called the compounding period or compounding periods per year. D) Although an APR is quoted on an annual basis, interest can be paid monthly but never daily.
D) Although an APR is quoted on an annual basis, interest can be paid monthly but never daily. Explanation: Interest CAN BE PAID DAILY (even though it may not be the common mode of payment).
8) Angel is seeking to expand her rare stamp collection. Each year, rare stamps increase in price at a three percent rate. She believes that if she invests her money for one year, she should be able to buy 16 stamps for what 15 stamps would cost today. What is her real interest rate (or reward for waiting)? A) Her real interest rate is about 4.23%. B) Her real interest rate is about 5.33%. C) Her real interest rate is about 6.33%. D) Her real interest rate is about 6.67%.
D) Her real interest rate is about 6.67%. Explanation: The real interest rate or reward is given by (FV/PV)^1/n-1 where FV = 16, PV = 15 and n = 1. We have: real interest rate or reward =(16/15)^1/1 -1= 0.0667 or 6.67%.
18) Which of the statements below is TRUE? A) The frequency of bankruptcy for a high-tech up-start firm is lower than for a blue-chip firm, so we see higher borrowing rates for start-ups than for mature firms. B) The frequency of bankruptcy for a high-tech up-start firm is higher than for a blue-chip firm, so we see lower borrowing rates for start-ups than for mature firms. C) The frequency of bankruptcy for a high-tech up-start firm is lower than for a blue-chip firm, so we see lower borrowing rates for start-ups than for mature firms. D) The frequency of bankruptcy for a high-tech up-start firm is higher than for a blue-chip firm, so we see higher borrowing rates for start-ups than for mature firms.
D) The frequency of bankruptcy for a high-tech up-start firm is higher than for a blue-chip firm, so we see higher borrowing rates for start-ups than for mature firms. Explanation: All other answers besides D have at least one word that disagrees with the correct words found in D.
19) Which of the statements below is FALSE? A) If you invest money for a short period and buy a six-month CD, you will not receive as high an interest rate as if you bought a CD with a longer maturity period. B) The difference in rates as the borrowing time or investment horizon increases is due to the maturity premium of the investments. C) The maturity premium represents that portion of the yield that compensates the investor for the additional waiting time or the lender for the additional time it takes to receive repayment in full. D) The longer the loan, the greater the risk of nonpayment and the lower the interest rate the lender demands.
D) The longer the loan, the greater the risk of nonpayment and the lower the interest rate the lender demands.
3) Suppose that over the life of the loan, the total interest expense for a monthly loan is $7,000, while the total interest payment for an annual loan is $8,000. Which of the below statements is FALSE? A) The difference reflects the reduction of the principal each month versus the annual reduction of the principal. B) The more frequent the payment, the lower the total interest expense over the life of the loan, even though the effective rate of the loan is higher. C) Reducing principal at a faster pace reduces the overall interest paid on a loan. D) The more frequent the payment, the lower the total interest expense over the life of the loan, even though the effective rate of the loan is lower.
D) The more frequent the payment, the lower the total interest expense over the life of the loan, even though the effective rate of the loan is lower. Explanation: The more frequent the payment, the lower the total interest expense over the life of the loan, even though the effective rate of the loan is HIGHER.
