intro to finance- chapter 6
Match the type of rate with its definition. APR EAR
-The interest rate per period multiplied by the number of periods in the year. -The interest rate stated as though it were compounded once per year.
A typical investment has a large cash_______ (inflow/outflow) at the beginning and then a cash ________ (inflows/outflows) for many years.
-outflow -inflows
Which of the following spreadsheet (Excel) functions will calculate the $614.46 present value of an ordinary annuity of $100 per year for 10 years at 10 percent per year?
=PV(.10,10,-100,0,)
True or false: The APR is always the same as the EAR.
False
True or false: There is only one way to quote interest rates.
False Reason: There are various ways to quote rates.
True or false: A fixed payment loan is most common for consumers.
True
In the standard present and future value tables, and in all the default settings on a financial calculator, the assumption is that cash flows occur at the ________(beginning/end) of each period.
end
The present value of a series of ________cash flows is the amount you would need today to exactly duplicate those future cash flows.
future
Given the same APR, more frequent compounding results in _____.
higher EARs
When valuing cash flows, you can either value multiple cash flows or a single sum, also known as a(n) _____ sum.
lump
Most investments involve _____ cash flows.
multiple
When using the spreadsheet (Excel) function for finding the PV of an annuity, it's a good idea to enter the ______ as a negative value.
payment Reason: If you do not enter the payment as a negative value, the result will be negative.
The loan balance on partial amortization loans declines so slowly because the ___.
payments are mostly interest
The formula for the ______ value interest factor of an annuity is {1-[1/(1+r)t]/r} Multiple choice question.
present
Amortization is the process of paying off loans by regularly reducing the _________.
principal
To use a present value of an annuity table to find the present value of an annuity factor, search the ______ for the number of periods and the ______ for the rate.
row; column
The APR is also called the ______ rate and it differs from the EAR.
stated
Semiannual compounding means that interest is paid ______ per year.
two times
Which of the following are true about a partial amortization loan?
-The amortization period is longer than the loan period. -The monthly payments do not fully pay off the loan by the end of the loan period. -The borrower makes a large balloon payment at the end of the loan period. -The monthly payment is based on a longer amortization period than the maturity of the loan.
Which of the following is true about a growing annuity?
-The cash flows grow for a finite period. -The cash flows grow at a constant rate.
Ralph has $1,000 in an account that pays 10 percent per year. Ralph wants to give this money to his favorite charity by making three equal donations at the end of the next 3 years. How much will Ralph give to the charity each year?
$402 Reason: Calculate the payment using the PV of an annuity at 10 percent for 3 years. $1,000/[(1 − 1/1.103)/0.10] = $402.11..11
You will receive a bonus of $5,000 in one year's time, and would like to take a loan against it now. What is the formula that shows how much you can borrow if you plan to use the entire amount to pay back the loan and your interest rate is 3%?
$5,000/1.03
Which of the following processes can be used to calculate future value for multiple cash flows?
-Compound the accumulated balance forward one year at a time -Calculate the future value of each cash flow first and then add them up
Which of the following payment methods amortizes a loan?
-Fixed payments that result in a zero loan balance -Interest plus fixed amount
Which of the following are annuities?
-Installment loan payments -Monthly rent payments in a lease
Which of the following are ways to amortize a loan?
-Pay the interest each period plus some fixed amount of the principal. -Pay principal and interest every period in a fixed payment.
Which of the following are real-world examples of annuities?
-Pensions -Mortgages
Which of the following is equal to an effective annual rate of 12.36 percent?
12%, compounded semiannually Reason: For annual compounding, the EAR is equal to the APR. For 12% compounded semiannually, EAR = (1 + 0.12/2)^2 -1 = 12.36%
To find the present value of an annuity of $100 per year for 5 years at 10 percent per year using the tables, look up the present value interest factor which is Blank______ and multiply that by Blank______.
3.7908; $100 Reason: To find the present value of an annuity of $100 per year for 5 years at 10 percent per year using the tables, look up the present value interest factor which is 3.7908 and multiply that by $100.
To find the present value of an annuity of $100 per year for 5 years at 10 percent per year using the tables, look up the present value interest factor which is _____ and multiply that by ______.
3.7908; $100 R eason: To find the present value of an annuity of $100 per year for 5 years at 10 percent per year using the tables, look up the present value interest factor which is 3.7908 and multiply that by $100.
Which compounding interval will result in the lowest future value assuming everything else is held constant?
Annual
Which type of amortization is most commonly used in the real world for mortgages and car loans?
Fixed payment
The formula for the present value interest factor for annuities is: Annuity present value factor = {1-[1/(1+r)^t]}/r
True
The present value interest factor for an annuity with an interest rate of 8 percent per year over 20 years is_______.
[1 − (1/1.08^20)]/.08
The formula for the annuity present value factor for a 30-year annuity with an interest rate of 10 percent per year is ______.
[1 − (1/1.1030)]/.10]
In almost all multiple cash flow calculations, it is implicitly assumed that the cash flows occur at the _____ of each period.
end
A growing annuity has a(n) ____.
finite number of growing cash flows
Compared to a comparable fixed payment loan, the total interest on a fixed principal loan is:
less.
A single cash flow is also known as a:
lump sum
One method of calculating future values for multiple cash flows is to compound the accumulated balance forward _____ at a time.
one year
The loan balance on _____ amortization loans declines so slowly because the payments are mostly interest.
partial
The original loan amount is called the _____.
principal
Interest paid twice a year is known as ______ compounding.
semiannual
An effective annual rate of 7.12 percent is equal to 7 percent compounded ______.
semiannually
Because of __________ and _________, interest rates are often quoted in many different ways.
tradition; legislation
What is the present value of an ordinary annuity that pays $100 per year for 20 years if the interest rate is 10 percent per year?
$100{[1 - (1/(1.10)20)]/0.10}
Which formula shows the present value of an ordinary annuity that pays $100 per year for three years if the interest rate is 10 percent per year?
$100{[1 − (1/(1.10)3)]/0.10}
Which of the following are true about the amortization of a fixed payment loan?
-The amount of interest paid decreases each period. -The principal amount paid increases each period.
Which of the following is a perpetuity?
A constant stream of cash flows forever
Which of the following is the simplest form of loan?
A pure discount loan
How frequently does continuous compounding occur?
Every instant
Which of the following is the formula for the future value of an annuity?
FV = C(((1+r)^t−1)/r )
The _____ percentage rate is the interest rate charged per period multiplied by the number of periods in a year.
annual
The _______ percentage rate is the interest rate charged per period multiplied by the number of periods in a year.
annual
The future value factor for a(n) _________ is found by taking the future value factor and subtracting one, then dividing this number by the interest rate.
annuity
The present value of a(n)_________ of C dollars per period for t periods when the rate of return or interest rate, r, is given by: C × (1 − [1/(1 + r)^t]/r)
annuity
An annuity due is a series of payments that are made ____.
at the beginning of each period
With a fixed payment loan, the amount of interest paid ________ (decreases/increases) each period.
decreases
With a fixed payment loan, the amount of interest paid _________ (decreases/increases) each period.
decreases
An annuity ______ is an annuity for which the cash flows occur at the beginning of each period.
due
An annuity_______ is an annuity for which the cash flows occur at the beginning of each period.
due
In the standard present and future value tables, and in all the default settings on a financial calculator, the assumption is that cash flows occur at the (beginning/end) of each period.
end
The present value of a series of future cash flows is the amount you would need today to _____.
exactly duplicate those future cash flows
The present value of a series of _______ cash flows is the amount you would need today to exactly duplicate those future cash flows.
future
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite
The most common way to repay a loan is to pay:
interest plus a fixed principal amount every period.
Payments in a partial amortization loan are based on the amortization period, not the loan period. The remaining balance is then:
paid off in a lump sum bullet payment.
The payments in a ______ amortization loan are NOT based on the life of the loan.
partial
he formula for the ______ value interest factor of an annuity is {1-[1/(1+r)t]/r}
present
Versus a similar fixed payment loan, the total interest on a fixed ______ loan is less.
principal
Versus a similar fixed payment loan, the total interest on a fixed _______ loan is less.
principal
With interest-only loans that are not perpetuities, the entire principal is _____.
repaid at some point in the future
Multiple Choice Question To use a present value of an annuity table to find the present value of an annuity factor, search the ______ for the number of periods and the ______ for the rate.
row; column
____________is the process of paying off loans by regularly reducing the principal.
Amortization
