FIN Test 2
Which of the following are characteristics of a perpetuity? Check all that apply.
- The present value of a perpetuity is calculated by dividing the amount of the payment by the investor's opportunity interest rate. - In a perpetuity, returns—in the form of a series of identical cash flows—are earned.
Ordinary annuity
A cash flow stream that is created by an investment or loan that requires its cash flows to take place on the last day of each quarter and requires that it last for 10 years.
Amortization schedule
A cash flow stream that is generated by a share of preferred stock that is expected to pay dividends every quarter indefinitely.
Perpetuity
A cash flow stream that is generated by a share of preferred stock that is expected to pay dividends every quarter indefinitely.
Time value of money
A concept that maintains that the owner of a cash flow will value it differently, depending on when it occurs.
Amortized loan
A loan in which the payments include interest as well as loan principal.
Opportunity cost of funds
A rate that represents the return on an investor's best available alternative investment of equal risk.
Annuity due
A series of equal cash flows that occur at the beginning of each of the equally spaced intervals (such as daily, monthly, quarterly, and so on).
Annual percentage rate
An interest rate that reflects the return required by a lender and paid by a borrower, expressed as a percentage of the principal borrowed.
Eric wants to invest in government securities that promise to pay $1,000 at maturity. The opportunity cost (interest rate) of holding the security is 13.80%. Assuming that both investments have equal risk and Eric's investment time horizon is flexible, which of the following investment options will exhibit the lower price?
An investment that matures in seven years (vs 6)
Which feature of a bond contract allows the issuer to redeem a bond issue immediately in its entirety at an amount greater than par value prior to maturity?
Call Provision
A bond's ______ gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions.
Call provision
The process for converting present values into future values is called _______ .
Compounding
A bond issuer is said to be in ________ if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue's restrictive covenants.
Default
Which term is used to describe a call provision in which the issuer is prevented from calling a portion or the entire issue for several years during the early years of the bond issue?
Deferred call provision
After the end of the second year and all other factors remaining equal, a future value based on compound interest will never exceed the future value based on simple interest.
FALSE
If the payment is less than the interest due, the ending balance of the loan will decrease.
FALSE
Ordinary annuities make fixed payments at the beginning of each period for a certain time period.
FALSE
A bond's ________ is generally $1,000 and represents the amount borrowed from the bond's first purchaser.
Face or maturity value
Which of the following is true about finding the present value of cash flows?
Finding the present value of cash flows tells you how much you need to invest today so that it grows to a given future amount at a specified rate of return.
Which of the following is true about present value calculations?
Other things remaining equal, the present value of a future cash flow decreases if the investment time period increases.
Time value of money calculations can be solved using a mathematical equation, a financial calculator, or a spreadsheet. Which of the following equations can be used to solve for the future value of a lump sum?
PV x (1 + r)^n
A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year is called a
Sinking fund provision
All other factors being equal, both the simple interest and the compound interest methods will accrue the same amount of earned interest by the end of the first year.
TRUE
An annuity due earns more interest than an ordinary annuity of equal time.
TRUE
An annuity due is an annuity that makes a payment at the beginning of each period for a certain time period.
TRUE
An annuity is a series of equal payments made at fixed intervals for a specified number of periods.
TRUE
The process of earning compound interest allows a depositor or investor to earn interest on any interest earned in prior periods.
TRUE
Treasury bonds are not completely riskless, since their prices will decline when interest rates rise.
TRUE
When the coupon rate is less than Oliver's required return, the bond should trade at a discount.
TRUE
Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions?
The bond will not be called.
Future value
The name given to the amount to which a cash flow, or a series of cash flows, will grow over a given period of time when compounded at a given rate of interest.
Discounting
The process of determining the present value of a cash flow or series of cash flows to be received or paid in the future.
Which of the following investments that pay will $18,500 in 8 years will have a higher price today?
The security that earns an interest rate of 8.50%. (vs 12.75)
When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at
a discount
When the bond's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will ___ its par value, and the bond will trade at a premium.
exceed
