Finance exam 1

In a Normal Distribution, there is a 68% chance that an actual return will exceed the average return minus one standard deviation.

False Correct: In a Normal Distribution, there is a 68% chance that an actual return will exceed the average return plus one standard deviation.

T/F: The number of years it would take an investment to double is approximately equal to the annual interest rate times

False correct: The number of years it would take an investment to double is approximately equal to the annual interest rate divide

T/F: The periodic rate will always be greater than the APR

False correct: The periodic rate will never be greater than the APR

T/F: We can find the amount needed to pay off a mortgage loan at any point in time by solving for the FV of the remaining payments.

False correct: We can find the amount needed to pay off a mortgage loan at any point in time by solving for the PV of the remaining payments.

How do you solve for each variable in the approximate Fisher Effect?

Add or subtract

What is meant by "Bid" and "Ask" prices?

Dealer (bid=buy ask=sell) Investor (bid=sell ask=buy)

What is the meaning of PV and FV?

Present value and future value

Par Value

The face value of a bond.

T or F: A simple percent change represents a change as part of the old or earlier value.

True

T/F: "PMT" in the PVA formula tells us the periodic mortgage payments for a fixed-rate fully amortized loan.

True

T/F: Capital losses always decrease the investors rate of returns

True

T/F: Ceteris paribus, as a depositor and for the same annual interest rate, you would prefer compound interest to simple interest.

True

T/F: Ceteris paribus, as the frequency of compounding increases, the APR will exceed the EAR by greater and greater amounts.

True

T/F: Ceteris paribus, bond prices move in the direct direction from their coupon rates

True

T/F: Ceteris paribus, the PV and the discount rate are inversely related.

True

How do you find the amount needed to fully pay off a fixed-payment fully-amortized loan?

We can find the amount needed to pay off a​ fixed-rate fully amortized mortgage loan at any point in time by solving for the PV of the remaining payments.

Zero Coupon Bonds

bonds that pay no annual interest but are sold at a discount below par, thus compensating investors in the form of capital appreciation

EAR

computed in order to evaluate the impact of interest rate change on earnings

Coupon Interest Rate

the stated annual interest rate on a bond

What are the 3 perspectives on the interest rate?

-Rental price of money - Lender: reward for postponing consumption -Borrower: want to spend before we earn (penalty

What is the relationship between the PV and the discount rate?

-inverseif -r goes up PV goes down

What is meant by a "lump sum"?

1 time cash flows

What are the 3 areas of corporate financial management decision making?

1. Capital Structure 2. Working Capital Management 3. Capital Budgeting

What are the 3 main determinants of stock prices and how does each affect the stock price

1. Cash flows (big as possible) 2. Timing of cash flows (soon as possible) 3. Risk (low as possible)

What is the overriding goal of corporate financial management and what are 3 ways of describing this goal?

1. Maximizing wealth of shareholder 2. Stock Price 3. Market Value of Equity

What are the 3 things that a time line shows?

1. Size (cash value) 2. Point in time 3. When its occurring 4. When its an inflow or outflow

Discount Bond

A bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate

Amortized Loan

A loan that is repaid in equal payments over its life.

APR

Annual percentage rate; the annual rate of interest that is charged for using credit

T/F: PVs are rightward on a time line and FVs are leftward on the time line.

False Correct: FVs are rightward on a time line and PVs are leftward on the time line. [

T/F: Given the amount needed at the beginning of the retirement period, the annual deposits needed during the working period can be found by solving for "PMT" in the PVA formula.

False correct: Given the amount needed at the beginning of the retirement period, the annual deposits needed during the working period can be found by solving for "PMT" in the FVA formula.

T/F: Lump sums are multiple cash flows.

False correct: Lump sums are single cash flows

T/F: We can determine which "PMT" we're being asked to solve for by noting what the problem provides in terms of r and n.

False correct: PMT function is use for determine annuity value when interest rate, tenure, present value or future value is given.

frequency compounding

How frequently interest is charged or credited to an account

T/F: FVs are later values and PVs are earlier values

True

T/F: For fixed-rate fully amortized mortgage loans, more of the fixed payment goes towards principal as we approach the end of the loan term.

True

T/F: Interest rates were high in the late 1970s and early 1980s because of inflation

True

YTM

Yield to Maturity the rate of return earned on a bond if it is held to maturity

Premium Bond

a bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate

ceteris paribus

all other things held constant

The penalty for spending before earning is the interest rate from the point of view of the

borrower

T/F: Par bonds sell for less than par value

false correct: Par bonds sell for the same par value

How do you use Excel functions to compute the FVA, PVA and PMT?

fv of annuity pv of annuity and payment

What does the Fisher Effect show?

it shows the relationship between real and nominal interest rates and inflation

How do current interest rates compare to those in the late 1970s-early 1980s and what accounts for the difference?

it was much lower

How do the various components of the loan amortization schedule change as the term of the loan progresses?

principal payment increases and interest payment decreases. Which lead to rapid reduction in loan ending balance as loan progresses.

What is the difference between simple and compound interest?

simple interest is only paid on principal, while compound interest is paid on the principal plus all of the interest that has previously been earned

What is the "Cycle of Money" between investors and a corporation?

the movement of money from lender to borrower and back again.

Why do we need to learn Time Value of Money (TVM) tools?

to understand a dollar in hand today is worth more than a dollar tomorrow (in the future)

T/F: In the period 1950-1999 changes in inflation were the main factors causing nominal interest rates to change.

true

T/F: When given the annual withdrawals desired during the retirement period, PVA tells us the amount we should have accumulated by the time we retire.

true

What are the 3 basic multiple cash flow patterns?

uneven stream, annuity, perpetuity

How do you solve for the PV and FV of an uneven stream?

use Ch. 3 lump sum formulas and add them up

What is the Rule of 72 and how is it used to solve for approximate values of r and n?

used to figure out the approximate number of years or approximate rate.

T/F: If you buy a bond at a discount and hold it to maturity, you will experience a capital lose

False Correct: If you buy a bond at a discount and hold it to maturity, you will experience a capital gain

Perpetuity

A stream of equal payments at fixed intervals expected to continue forever.

What is meant by real and nominal interest rates?

A real interest rate is adjusted to remove the effects of inflation and gives the real rate of a bond or loan. A nominal interest rate refers to the interest rate before taking inflation into account.

periodic interest rate

The interest rate per period. It can be found by dividing the annual interest rate by the number of periods per year.

Coupon Payment

The specified number of dollars of interest paid each year. Coupon payment =coupon rate * par value

T or F: To change a decimal value to a percent, divide by 10

False Correct: To change a decimal value to a percent, multiple by 100

What is involved with discounting and compounding?

1. Discounting: the process of determining the present value of the amount to be received in the future 2. Compounding: method is used to know the future value of present money.

Uneven Cash Flows

A series of cash flows where the amount varies from one period to the next.

Annuity

A series of equal payments at fixed intervals for a specified number of periods.

For lump sums, how do you solve for PV, FV, r and n?

FV=PV(1+r)^n

T/F: A $1000 par value bond with an annual coupon rate of 5% would pay $100 in interest every 1 year

False correct: A $1000 par value bond with an annual coupon rate of 5% would pay $50 in interest every 1 year

T/F: At maturity, investors must repay a bond's par value to its issuer

False correct: At maturity, issuer must repay a bond's par value to its investors

T/F: Discount bonds are always worth less than par value at maturity

False correct: Discount bonds are always worth the same as par value at maturity

T/F: PVs represent the amount that an earlier amount will grow into.

False correct: FVs represent the amount that an earlier amount will grow into.

T/F: The interest part of a fixed mortgage loan payment can be found by multiplying the periodic interest rate by the ending balance for a given period.

False correct: The interest part of a fixed mortgage loan payment can be found by multiplying the periodic interest rate by the beginning balance for a given period.

T/F: The right-hand side variables in the FV formula represent the 3 key factors determining stock prices.

False correct: The right-hand side variables in the PV formula represent the 3 key factors determining stock prices.

T/F: We can find nominal interest rate by subtracting the default and maturity premiums from the sum of the real rate and inflation

False correct: We can find nominal interest rate by adding the default and maturity premiums from the sum of the real rate and inflation

T/F: With compound interest, interest is earned every period only on the original starting amount.

False correct: With simple interest, interest is earned every period only on the original starting amount.

T/F: Discounting is the process used to find a FV

False correct: compounding is the process used to find a FV

T/F: Annuities are equal cash flows that go on forever.

False correct: perpetuity are equal cash flows that go on forever.

T or F: According to the Order of Operations, exponents are applied before the expression in parentheses, division is to be completed before multiplication, and addition and subtraction are to be completed before multiplication and division.

False Correct: According to the Order of Operations, exponents are applied After the expression in parentheses, division is to be completed at the same time. Multiplication, and addition and subtraction are to be completed after multiplication and division.

How do changes in the Right-Hand-Side variables affect PV and FV?

Future value has a positive correlation with PV, r, and n. Present value has a positive correlation with FV but a negative correlation with r and n

How do changes in the Right-Hand-Side variables affect PV and FV?

Future value has a positive correlation with PV, r, and n. Present value has a positive correlation with FV but a negative correlation with r and n

How do the various components of the fixed-payment loan amortization schedule change as the term of the loan progresses?

Over the term of the loan progress principal payment increases and interest payment decreases. Which lead to rapid reduction in loan ending balance as loan progresses

How do you determine which of the 3 "PMTs" you need to solve for?

PMT: If the cash flows form annuity or perpetuity, we solve for PMT IPMT: If the interest payment (IPMT) at a particular period for an investment or Loan based on an interest rate and a constant payment schedule is asked, we solve for IPMT Excel formula for IPMT is IPMT( interest_rate, period, number_payments, PV, [FV], [Type] ) where period indicates the nth period at which the interest payment IPMT is calculated PPMT: If the Principal payment (PPMT) at a particular period for an investment or Loan based on an interest rate and a constant payment schedule is asked, we solve for PPMT Excel formula for PPMT is PPMT( interest_rate, period, number_payments, PV, [FV], [Type] ) where period indicates the nth period at which the principal payment IPMT is calculated

How do you solve for targeted savings by retirement and savings required to reach that target?

Targeted Savings for retirement is nothing but the present value of all those future withdrawals a person wish to make after the retirement. We just build a timeline consisting of all his future withdrawals after retirement and discount all of them to find their present value which is the targeted savings needed. Savings required to reach that target are the contributions made by the person from the time he decided to save to till the date he decided to make contributions to the retirement fund so that, the present value of all these savings equals to the targeted savings calculated by us above.

What do the time subscripts in the PVA and PVP formulas tell us?

The time subscript in the PVA (Present Value of Annuity) & PVP (Present Value of Perpetuity) formulae tell us the time period to which all the cash flows of the annuity & perpetuity are discounted.

T/F: PVs represent what you need to invest earlier to have it grow into a specified later amount.

True

T/F: The Fisher Effect illustrates the direct relationship between inflation and nominal interest rates.

True

T/F: The YTM on a premium bond will be below its coupon rate

True

T/F: There are 3 formulas on our formula sheet for Chapter 4 that contain the variable "PMT".

True

T/F: There are a total of 4 variables in the basic Chapter 3 TVM formulas

True

T/F: We've discussed 3 different multiple cash flow patterns.

True

T/F: What is "discounted" from the FV is the interest part to arrive at the PV.

True

T/F: You can earn high returns by purchasing zero-coupons bonds at a discount rate

True