Chapter 6

A monthly interest rate expressed as an annual rate would be an example of which one of the following rates?

effective annual rate

An ordinary annuity is best defined by which one of the following?

equal payments paid at regular intervals over a stated time period

A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) _____ loan.

pure discount

The entire repayment of which one of the following loans is computed simply by computing a single future value?

pure discount loan

Which one of the following accurately defines a perpetuity?

unending equal payments paid at equal time intervals

You are comparing two annuities which offer quarterly payments of $2,500 for five years and pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while annuity B will pay you on the last day of each month. Which one of the following statements is correct concerning these two annuities?

Annuity B has a smaller present value than annuity A.

How is the principal amount of an interest-only loan repaid?

C. The principal is repaid in a lump sum at the end of the loan period.

Which one of the following statements concerning interest rates is correct? A. Savers would prefer annual compounding over monthly compounding. B. The effective annual rate decreases as the number of compounding periods per year increases. C. The effective annual rate equals the annual percentage rate when interest is compounded annually. D. Borrowers would prefer monthly compounding over annual compounding. E. For any positive rate of interest, the effective annual rate will always exceed the annual percentage rate.

C. The effective annual rate equals the annual percentage rate when interest is compounded annually.

Which one of these statements related to growing annuities and perpetuities is correct? A. The cash flow used in the growing annuity formula is the initial cash flow at time zero. B. Growth rates cannot be applied to perpetuities if you wish to compute the present value. C. The future value of an annuity will decrease if the growth rate is increased. D. An increase in the rate of growth will decrease the present value of an annuity. E. The present value of a growing perpetuity will decrease if the discount rate is increased.

E. The present value of a growing perpetuity will decrease if the discount rate is increased.

Which one of the following statements correctly states a relationship? A. Time and future values are inversely related, all else held constant. B. Interest rates and time are positively related, all else held constant. C. An increase in the discount rate increases the present value, given positive rates. D. An increase in time increases the future value given a zero rate of interest. E. Time and present value are inversely related, all else held constant.

E. Time and present value are inversely related, all else held constant.

You are comparing two investment options that each pay 5 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays three annual payments starting with $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options?

Option B has a higher present value at time zero than does option A.

Which one of the following terms is used to describe a loan wherein each payment is equal in amount and includes both interest and principal?

amortized loan

You need $25,000 today and have decided to take out a loan at 7 percent for five years. Which one of the following loans would be the least expensive? Assume all loans require monthly payments and that interest is compounded on a monthly basis.

amortized loan with equal principal payments

Which one of the following terms is defined as a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum?

balloon loan

Which one of the following terms is used to identify a British perpetuity?

consol

Which one of the following compounding periods will yield the smallest present value given a stated future value and annual percentage rate?

continuous

An amortized loan:

may have equal or increasing amounts applied to the principal from each loan payment.

The interest rate that is quoted by a lender is referred to as which one of the following?

stated interest rate

Which one of the following statements related to annuities and perpetuities is correct? A. An ordinary annuity is worth more than an annuity due given equal annual cash flows for ten years at 7 percent interest, compounded annually. B. A perpetuity comprised of $100 monthly payments is worth more than an annuity comprised of $100 monthly payments, given an interest rate of 12 percent, compounded monthly. C. Most loans are a form of a perpetuity. D. The present value of a perpetuity cannot be computed, but the future value can. E. Perpetuities are finite but annuities are not.

A perpetuity comprised of $100 monthly payments is worth more than an annuity comprised of $100 monthly payments, given an interest rate of 12 percent, compounded monthly.

What is the interest rate charged per period multiplied by the number of periods per year called?

annual percentage rate

Which of the following statements related to interest rates are correct?I. Annual interest rates consider the effect of interest earned on reinvested interest payments.II. When comparing loans, you should compare the effective annual rates.III. Lenders are required by law to disclose the effective annual rate of a loan to prospective borrowers.IV. Annual and effective interest rates are equal when interest is compounded annually.

II and IV

Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment?

interest-only loan