Finance Exam 2

"PMT" in the FV Formula tells us the periodic mortgage payments for a fixed-rate fully amortized loan

False, PV formula

Relationships of PV, r, and n with FV

If PV increases FV increases if r increases FV increases if n increases FV increases

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

True

in bond problems r = ?

YTM

maturity premium

borrowing for a longer period of time equals a higher premium

in bond problems pmt = ?

coupon

h

inflation rate

3 golden rules for bonds

1) r, n, pmt must all have equal frequencies 2) semi annual bonds: coupon=annual coupon/2, # of years x2, and r=YTM/2 3) price of bond at any point in time is present value of remaining cash flows

EAR

Effective annual rate

a $1,000 par value bond with an annual coupon rate of 5% would pay $100 in interest every 6 months

False, $25 every 6 months

there are 4 formulas on our formula sheet that contain the variable PMT

False, 3

There are a total of 3 variables in the basic TVM formulas

False, 4 variables FV, PV, n, r

Ceteris paribus, as the frequency of compounding increases, the APR will exceed the EAR by greater and greater amounts

False, EAR will exceed APR

the FV tells us the one time deposit we must make to reach a targeted retirement savings goal

False, PV

PVs are later values and FVs are earlier values

False, PVs are earlier FVs are later

PVs are rightward on a time line and FVs are leftward on the timeline

False, PVs are leftward, FVs are rightward

The periodic rate will always be greater than the APR

False, The periodic rate will always be smaller than APR, unless it is for every 2 years

the YTM on a premium bond will be above its coupon rate

False, YTM less than coupon rate

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

False, add them

You cant go wrong by purchasing zero-coupon bonds at a premium

False, always at a discount

interest rates were high in the late 1970s and early 1980s because of low default premiums

False, because of inflation

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, by solving for PV

Capital losses always increase the investor's rate of return

False, decrease

par bonds always sell for less than par value

False, equal to par value

For fixed-rate fully amortized mortgage loans, more of the fixed payment goes towards interest as we approach the end of the loan term

False, goes towards the principal

In the period 1950-1999 changes in the real rate were the main factor causing nominal interest rates to change

False, inflation

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, multiplying the periodic interest rate by the beginning balance

Discount bonds are always worth less than par value at maturity

False, not price at time of maturity

Bond prices move in the same direction as market interest rates

False, opposite direction (inverse)

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

False, point of view of the borrower

The fisher Effect illustrates the inverse relationship between inflation and nominal interest rates

False, positive relationship

ceteris paribus, as a depositor and for the same annual interest rate, you would prefer simple interest to compound interest

False, prefer compound

Discounting is the process used to find a FV

False, process of finding PV

at maturity, investors must repay a bond's par value to its issuer

False, receive

what is "discounted" from the PV is the interest part to arrive at the FV

False, replace discounted with compounded

PVS represent the amount that an earlier amount will grow into

False, represent initial amount

With compound interest, interest is earned every period only on the original starting point

False, simple interest compound interest is interest earned on interest

On the time line for a retirement period, "PMT" in the PV formula tells us the recurring deposits that must be made earlier in order to reach a targeted retirement savings goal

False, the FV formula

On the time line for a retirement period, the FV tells us the amount we should have accumulated by the time we retire

False, the PV

FV

Future Value at time "n"

If using a financial calculator for annuity what is PV equaled too?

PV = 0

How to consider cash flows in multiple cash flows

Separately

the right-hand side variables in the FV formula represent the 3 key factors determining stock prices

True

amortized loan is similar to...

annuities

zero coupon

coupon equals zero, or no coupons

3 different loan payments

discount loan interest only loan amortized loan

annuity

equal cash flows for a period of time

perpetuity

equal cash flows forever

amortized loan

equal periodic payments principal and interest

If you own long-term zero-coupon bonds, you would hope that interest rates would increase

false interest, rates decrease

we've discussed 4 different multiple cash flow patterns

false, 3 annuity, perpetuity, unequal

FVs represent what you need to invest earlier to have it grow into a specified later amount

false, are the amount that the investment grows into

The FV and the discount rate are inversely related

false, directly related

the number of years it would take an investment to double is approximately equal to the annual interest rate times 72

false, n=72/r

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, need FV, PV, n (fixed or forever)

lump sums are multiple cash flows

false, one cash flow

annuities are equal cash flows that go on forever

false, perpetuity goes on forever

annuities happen at...

fixed intervals, same amount

Par value

future value

the 3 perspectives

general lender borrower

who can issue bonds?

government, corporation, individual

relationships of FV, n, and r with PV

if FV increases PV increases if n increases PV decreases if r increases PV decreases

APR

interest rate for a year

bond

long term debt instrument

History: rank most important inflation real interest rate default premium maturity premium

most important: inflation maturity premium real interest rate default rate

r

nominal interest rate

m

number of payments in a year. (multiply n * m for total payments)

n

number of periods

borrower perspective

penalty for spending before earning

interest only loan

periodic interest principals at end

type of relationship between inflation and interest rate

positive

PV

present value at time zero in your time table. brings cash flows to year zero

Discount Loan

principle and interest is paid in lump sum

r*

real interest rate

compound interest

receive interest on interest

general perspective

rental price of money

lender perspective

reward for postponing spending

Default premium

risk that you wont receive money because person defaults

three factors in determining stock prices

time (-), risk(-), future value(+)

types of multiple cash flows

unequal CFs, equal CFs for a period of time, equal CFs forever

coupon

way of raising money for a corporation