MGF 301 Chapter 5
A dollar invested today at 7.5 percent simple annual interest will be worth _______ one year from now
$1.075 Rationale: FV = $1.00 + $0.075
A dollar invested today at 8.0 percent simple annual interest will be worth _________ three years from now.
$1.24 Rationale: With simple interest, the bank calculates interest only on the principal investment: $1.00 + $.08 + $.08 + $.08 = $1.24. Do not confuse this with compound interest, which computes interest earned on interest
A dollar invested today at 8.0 percent interest compounded annually will be worth _______ three years from now.
$1.2597 Rationale: FV=$1.00(1+0.08)3
In 2013 the CPI was about 2.5 times its level in 1981. If the cost of one semester of college was $5000 in 1981, what should the nominal cost of a semester of college be in 2013 assuming the real price is constant?
$12,500
What is the future value of $100 invested for 4 years at 10% interest?
$146.41 Rationale: FV = $100 x (1+r)t = $100 x (1+.1)4=$146.41
Assume you have $100 to invest today. Investing it at 5% interest compounded annually will yield _______ in 10 years, while investing it at 6% interest compounded annually will yield _______ in 10 years.
$162.89; $179.08
If the interest rate is 10% per year, then what is the present value (PV) of $100 received one year from today?
$90.00 Rationale: PV = $100/1.10 = $90.91
Compound growth means that value increases after t periods by:
(1 + growth rate)t
Compound growth means that value increases after t periods by:
(1 + growth rate)t Rationale: (1 + growth rate)t
If a bank quotes a loan with an APR of 15 percent, compounded monthly, what is the periodic rate on this loan?
1.25 percent 15/12 = 1.25 percent
Which of the following is the correct formula for the discount factor?
1/(1+r)t
How much is $100 at the end of each year forever at 10% interest worth today?
1000
$200 at the end of each year forever at 10% per year is worth how much today?
2000
Which of the following is a perpetuity?
A constant stream of cash flows forever
Inflation can be defined as:
An overall general rise in prices
Which of the following are annuities?
Annual installment loan payments Yearly lease payments
______ dollars refer to the actual number of dollars of the day, whereas ______ dollars refer to the amount of purchasing power.
Current, constant Nominal, real
Which of the following is the correct equation for the present value of an annuity with regular payment C for t periods at interest rate r?
PV = C[1/r - 1/r(1+r)t]
If the interest rate (r) increases, what will happen to present value (PV) over time?
PV will decline
Your insurance agent wants to sell you an annuity consisting of 20 equal end of year payments of $10,000 each, starting at the end of this year. Your desired rate of return for investments of this type is 7 percent. What is the most you would pay for this annuity today?
Rationale: PV = 10000[1/0.07 - 1/0.07(1.07)20] = 105,940.14 $105,940.14
True or false: the discount factor refers to the present value of a $1 future payment.
T
True or false: the nominal interest rate can be defined as an interest rate quoted today by a financial institution on a loan or investment, such as an APR or a periodic rate.
T
The real interest rate can be defined as:
The real change in value of an investment (or a real cost of a loan) after adjustment for inflation
The effective annual interest rate is also known as the ______________.
annually compounded rate
A fixed stream of cash flows that ends after a specified number of years is called a(n):
annuity
A series of level payments that begins immediately for a specified period of time is called a(n):
annuity due
The present value of an annuity of $1 per period is called the ______________.
annuity factor
Joseph signs a contract with a company that will pay him $25,000. Following the principles of the time value of money, Joseph would be best off if he received payment:
at the beginning of the project
An ordinary annuity is a series of level payments that begin ____.
at the end of one payment period
If interest rates go up, the present value of a perpetuity will ______.
decrease
At a rate of interest of 10% (r), the present value (PV) or $100 will ___________ as the time period (t) ________________.
decrease; increases
Interest income is _____________ to interest rate.
directly proportional
Another name for the interest rate used to calculate PV is the ______ rate.
discount
Discounting a future value FV at interest rate r over time t is termed a ______________ calculation.
discounted cash-flow
Present value is calculated using a ____________________ calculation.
discounted cash-flow
A traditional (non-growing) annuity consists of a(n) ________ stream of cash flows for a fixed period of time.
fixed
The value in t years of an investment made today at interest rate r is called the ___________ of your investment.
future value
If the interest rate is greater than zero, the present value of an annuity due is always ______ an ordinary annuity.
greater than
An annuity due is a series of level payments that begin ____.
immediately
If interest rates go down, the present value of a perpetuity will _____________.
increase
In 2013 the CPI was about 2.5 times its level in 1981. If the price of a pack of cigarettes was $1.00 in 1981 and $5.00 in 2013, then the real price has ______ since 1981. The inflation-adjusted price today should be _______ if there had been no real growth in the price of a pack.
increased; $2.50
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite Rationale: A perpetuity is a constant stream of cash flows for an infinite time period.
When money is invested at compound interest, the growth rate is equal to the __________
interest rate
When money is invested at compound interest, the growth rate is equal to the __________.
interest rate
If you are promised $100 in one year, $200 in two years, and $300 in 3 years, then those promises combined equal ______ $600 today.
less than Rationale: This relates to the time value of money concept - $1 is worth more today than it is in the future. Therefore, any funds that you receive in the future will be worth less than they are if you received them today.
The time value of money concept states that a dollar today is worth _______ a dollar tomorrow.
more than
Which type of interest rate is generally quoted for loans and by banks and other financial institutions?
nominal
A stream of cash flows means that ________.
payments are made over time
C/r is the formula for the present value of a(n) ____.
perpetuity
The present value of an annuity due is equal to the:
present value of an ordinary annuity x (1+r)
Which type of price refers to the of purchasing power of money?
real
The equation used to determine the approximate real interest rate is:
real interest rate= nominal interest rate - inflation rate
Real-world investments often involve many payments received or paid over time. Managers refer to this as a ___________________.
stream of cash flows
The best known price index used by economists who measure inflation is ________.
the consumer price index (CPI)
The Annual Percentage Rate (APR) on a loan or investment is properly defined as
the interest rate per period multiplied by the number of compounding periods per year
The Annual Percentage Rate (APR) on a loan or investment is properly defined as:
the interest rate per period multiplied by the number of compounding periods per year
Which of the following is a proper definition for the effective annual interest rate?
the interest rate that is annualized using compound interest
