Finance Chapters 4-6 Exam 2
To find the present value of an annuity of $100 per year for 10 years at 10% per year using the tables, find a present value factor of 6.1446 and multiply it by ______.
$100
ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?
$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years.
What are municipal bonds?
Bonds issued by state and local governments
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
A zero-coupon bond is a bond that ____.
makes no interest payments
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
Using a time value of money table, what is the future value interest factor for 10 percent for 2 years?
1.21
Using a time value of money table, what is the future value interest factor for 20 percent for 2 years?
1.4400
If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.
5% (Interest income from munis is exempt from federal income tax)
Crossover bonds can also be called _____ bonds.
5B
Which of the following is the correct Excel function to calculate the present value of $300 due in 5 years at a discount rate of 10%?
=PV(0.10,5,0,-300)
Which of the following is the simplest form of loan?
A pure discount loan
True or false: Given the PV, FV, and payment amount, you can determine the number of periods.
False
What is the asked price?
It is the price at which an investor can buy a particular security from a dealer; it is the price at which a dealer is willing to sell a particular security
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
What are some features of the OTC market for bonds?
OTC dealers are connected electronically. The OTC has no designated physical location.
What variables are required to calculate the value of a bond?
Remaining life of bond Coupon rate Market yield to maturity
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
The 10-year bond
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What are the three components that influence the Treasury yield curve?
The real rate of return Expected future inflation The interest rate risk premium
Which of the following are usually included in a bond's indenture?
The total amount of bonds issued The repayment arrangements
Which of the following are true of bonds?
They are issued by both corporations and governments They are normally interest-only loans
The US government borrows money by issuing:
Treasury notes and treasury bonds
True or false: A put bond allows the holder to force the issuer to buy the bond back at a stated price.
True
Future value is the __ value of an investment at some time in the future.
cash
Future value is the ________ value of an investment at some time in the future.
cash
The effective annual rate (EAR) takes into account the ______ of interest that occurs within a year.
compounding
One step in calculating an EAR is to ____ the quoted rate by the number of times that the interest is compounded.
divide
A key difference between interest payments and dividend payments is?
dividends are not tax deductible interest is tax deductible
A bond with a BB rating has a ______ than a bond with an BBB rating.
higher risk of default
Which three of the following are common shapes for the term structure of interest rates?
humped downward sloping upward sloping
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ____.
increases
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite
When finding the present or future value of an annuity using a financial calculator, the ______ ______ should be entered as a percentage.
interest rate
The annuity present value factor equals one ____ the present value factor all divided by the discount rate.
minus
Which of the following could not be evaluated as annuities or annuities due?
monthly electric bills tips to a waiter
Bonds issued by state and local governments are called _______ ______.
municipal bonds
When using a financial calculator to find the number of payments, the PMT value should be entered as a _____.
negative
Using an Excel spreadsheet to solve for the payment in an amortized loan, enter the number of periods as the ____ value.
nper
The current value of a future cash flow discounted at the appropriate rate is called the _____ value.
present
Because of __________ and _________, interest rates are often quoted in many different ways.
tradition; legislation
If you invest at a rate of r for __ periods, under compounding, your investment will grow to (1+r)^2 per dollar invested.
two
The first cash flow at the end of Week 1 is $100, the second cash flow at the end of Month 2 is $100, and the third cash flow at the end of Year 3 is $100. This cash flow pattern is a(n) ______ type of cash flow.
uneven
True or false: The process of leaving your money and any accumulated interest in an investment for more than one period is called multiplied interest.
False
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
Time to maturity Coupon rate
In the Excel setup of a loan amortization problem, which of the following occurs?
To find the principal payment each month, you subtract the dollar interest payment from the fixed payment. The payment is found with = PMT(rate, nper, -pv, fv).
True or false: The annuity present value of an amount C is calculated as C multiplied by {1-[1/(1+r)t]} / r
True
The idea behind ______ is that interest is earned on interest.
compounding
A bond's _____ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
coupon
The bid-ask spread represents the ___.
dealer's profit
When interest rates in the market rise, we can expect the price of bonds to ____.
decrease
The cash flows of an annuity due are the same as those of an ordinary annuity except that there is an extra cash flow at Time ____.
zero
If you invest for a single period at an interest rate of r, your money will grow to ______ per dollar invested.
(1+r)
A corporate bond's yield to maturity:
Changes over time Is usually not the same as bonds coupon rate
Which of the following processes can be used to calculate the future value of multiple cash flows?
Compound the accumulated balance forward one year at a time Calculate the future value of each cash flow first and then sum them
What is a bond's current yield?
Current yield = annual coupon payment / price
The general formula for ______ is (1+quoted rate/m)^m - 1.
EAR
Which of the following is the appropriate spreadsheet function to convert a quoted rate of 12% compounded quarterly to an EAR?
EFFECT(0.12,4)
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
Using the PV, discount rate, and , __ ,you can determine the number of periods. (Enter abbreviation only.)
FV
When calculating annuity present values using a financial calculator, the ______ amount is left blank. (Enter the abbreviation only.)
FV
True or false: Bond ratings are concerned only with the possibility of price changes.
False
True or false: Future value refers to the amount of money an investment is worth today.
False
True or false: If the interest rate is greater than zero, the value of an annuity due is always less than an ordinary annuity.
False
True or false: The interest rate charged per period on a loan divided by the number of periods per year equals the annual percentage rate.
False
True or false: The payment for an annuity can be calculated using the annuity present value, the present value factor, and the interest rate.
False
True or false: When using a financial calculator to find the number of payments, the PMT value should be entered as a positive.
False
True or false: With interest-only loans, the principle is never repaid.
False
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
What is the bid price?
It is the price at which a dealer is willing to buy securities. It is the price an investor will receive if he sells a bond to a dealer.
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
You are solving a present value equation using a financial calculator and are given the number of years for compounding. This should be entered as the _____ value on the financial calculator.
N
If FV= PV x (1+r) is the single period formula for future value, which of the following is the single period present value formula?
PV = FV/(1+r)
What four variables are required to calculate the value of a bond?
Par value Coupon rate Time remaining to maturity Yield to maturity
Which of the following terms apply to a bond?
Par value Coupon rate Time to maturity
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
Pay $800 today and receive $1,000 at the end of 5 years
Which of the following are real-world examples of annuities?
Pensions Mortgages Leases
As a general rule, which of the following are true of debt and equity?
The maximum reward for owning debt is fixed. Equity represents an ownership interest.
What does the clean price for a bond represent?
The quoted price excluding accrued interest
True or false: A simple way to amortize a loan is to have the borrower pay the interest each period plus a fixed amount.
True
True or false: Given the PV, FV, and life of the investment, you can determine the discount rate.
True
True or false: Interest rates can be quoted in various ways.
True
True or false: Long-term debt has maturities greater than one year.
True
True or false: Low-grade bonds may not be rated by major rating agencies.
True
True or false: The government sells Treasury notes and bonds to the public every month.
True
True or false: The perpetuity present value can be found using the perpetual cash flow and the discount rate.
True
True or false: To find the future value of multiple cash flows, calculate the future value of each cash flow first and then sum them.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True (Invoice price = clean price + accrued interest)
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
Upward sloping
What is a corporate bond's yield to maturity (YTM)?
YTM is the expected return for an investor who buys the bond today and holds it to maturity. YTM is the prevailing market interest rate for bonds with similar features.
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
Which of the following are bonds that have actually been issued?
a put bond a CoCo bond a convertible bond
The most common way to repay a loan is to pay ____.
a single fixed payment every period
The coupon payments on floating-rate bonds are _____.
adjustable
The interest rate charged per period multiplied by the number of periods per year is equal to ___ ___ ___ on a loan.
annual percentage rate
An annuity with payments beginning immediately rather than at the end of the period is called an _________.
annuity due
To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.
annuity present value
If bonds for AT&T are quoted at 115, they can be purchased:
at 115% of par value plus accrued interest
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
at 99.5 percent of face value plus any accrued interest
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
Assume interest is compounded monthly. The ______ annual rate will express this rate as though it were compounded annually.
effective
In almost all multiple cash flow calculations, it is implicitly assumed that the cash flows occur at the _____ of each period.
end
Spreadsheet functions used to calculate the present value of multiple cash flows assume, by default, that all cash flows occur at the _______ of the period.
end
EAR = (1 + quoted rate / m)^m - 1
equation
A limitation of bond ratings is that they ____.
focus exclusively on default risk
The present value is the current value of _ the cash flows discounted at the appropriate discount rate.
future
If the interest rate is greater than zero, the value of an annuity due is always ______ an ordinary annuity.
greater than
When finding the present or future value of an annuity using a spreadsheet, the ______ ______ should be entered as a decimal.
interest rate
What does the dirty price represent?
it includes the quoted price and accrued interest
An ordinary annuity consists of a(n) ________ stream of cash flows for a fixed period of time.
level
Given an investment amount and a set rate of interest, the _____ the time horizon the _____ the future value.
longer; greater
A simple way to amortize a loan is to have the borrower pay the interest each period plus some fixed amount. This approach is common with _____-term business loans.
medium
Equity represents a(n) _________ interest of a firm.
ownership
The _____ for an annuity can be calculated using the annuity present value, the present value factor, and the discount rate.
payment
C/r is the formula for the present value of a(n) ____.
perpetuity
The present value formula for a(n) ______ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate.
perpetuity
present value can be found using the perpetual cash flow and the discount rate.
perpetuity
Amortization is the process of paying off loans by regularly reducing the _________.
principal
The original amount of a loan is termed the loan ___________.
principal
What are the two major forms of long-term debt?
public issue and private issue
If you borrow $15,000 today at 5% annual interest to be repaid in one year as a lump sum, this is termed a _______________ .
pure discount loan
Compounding during the year can lead to a difference between the ____ rate and the effective rate.
quoted or stated
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
With typical interest-only loans, the entire principal is:
repaid at some point in the future
With _ interest, the interest is not reinvested
simple
Bond ratings are based on the probability of default risk, which is the risk that ___.
the bond's issuer may not be able make all the required payments
The term structure of interest rates describes ________.
the pure time value of money the relationship between nominal rates and time to maturity
Junk bonds have the following features:
they are rated below investment grade bonds
The real world has moved away from using _____________________________ for calculating future and present values.
time value of money tables
The formula for the future value of an annuity factor is [(1+r)^t -1]/r.
true
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
Which of the following spreadsheet functions will calculate the $614.46 present value of an ordinary annuity of $100 per year for 10 years at 10% per year?
=PV(0.10,10,-100,0,0)
Which of the following is a perpetuity?
A constant stream of cash flows forever
Which of the following methods are used to calculate present value?
A financial calculator An algebraic formula A time value of money table
To calculate the future value of $100 invested for t years at r interest rate, you enter the present value in your calculator as a negative number. Why?
Because the $100 is an outflow from you which should be negative.
Multi-Period Formula for Compounding a present value into a future value
FV = PV×(1 + r)^t
An annuity due is a series of payments that are made ____.
at the beginning of each period
More frequent compounding leads to:
Higher EARs
Formula for calculating the present value of a future amount, expected in t years at r per cent interest
PV = FV/(1+r)^t
Which of the following is the correct formula for calculating the present value of a future amount, expected in t years at r per cent interest?
PV = FV/(1+r)^t
The basic present value equation is:
PV = FVt/(1 + r)^t
Which of the following are ways to amortize a loan?
Pay principal and interest every period in a fixed payment. Pay the interest each period plus some fixed amount of the principal.
What is the primary difference between time value of money data entries in your calculator and in a spreadsheet function?
The interest rate in your calculator is entered as a whole number while in the spreadsheet function it is entered as a decimal.
True or false: When calculating the present value of an annuity using the financial calculator, you enter the cash flows of the annuity in the PMT key.
True
For a given time period (t) and interest rate (r), the present value factor is _______ the future value factor. (Select all that apply.)
1 divided by, the reciprocal of
Formula for a present value factor
1/(1+r)^t
True or false: If you invest for two periods at an interest rate of r, then your money will grow to (1 + r) per dollar invested.
False
True or false: The annuity due calculation assumes cash flows occur evenly throughout the period.
False
True or false: The annuity present value factor equals one minus the discount rate all divided by the present value factor.
False
True or false: The effective annual rate is the interest rate expressed in terms of the interest payment made each period.
False
True or false: The present value is the sum of all expenses in a project.
False
True or false: To find the annuity future value factor, you only need the cash flows and the discount rate.
False
True or false: Using the spreadsheet formula to convert a quoted rate (or an APR) to an effective rate, use the formula NOMINAL(effect_rate, npery).
False
True or false: When entering the interest rate in a financial calculator, you should key in the interest rate as a decimal.
False
Which of the following are the primary as well as easy ways used to perform financial calculations today?
Financial calculator Spreadsheet functions
When entering variables in a spreadsheet function (or in a financial calculator) the "sign convention" can be critical to achieving a correct answer. The sign convention says that outflows are negative values; inflows are positive values. For which variables is this a consideration?
present value payment future value
With discounting, the resulting value is called the _____ value; while with compounding the result is called the ____ value.
present; future
Which of the following is the formula for the future value of an annuity factor?
( (1+r)t−1 ) / r
Which of the following is the general formula for the EAR when m is the number of times interest is compounded in a year?
(1+quoted rate/m)^m - 1
The formula for the present value of an annuity due is:
(1+r)×(PV of an ordinary annuity)
Which of the following is not a way to amortize a loan?
Fixed interest payments only
In a present value equation, the _ rate can be found using the PV, FV, and t
discount
Calculating the present value of a future cash flow to determine its worth today is commonly called ___________ valuation.
discounted cash flow (DCF)
The amount an investment is worth after one or more periods is called the _____ value.
future
When dealing with compound interest, it is more financially advantageous to have a _____ time horizon for investment.
longer
The present value of an annuity due is equal to the present value of a(an) ______ annuity multiplied by (1+ r).
ordinary
The entire principal of an interest-only loan is the:
original loan amount
The formula for the ______ value interest factor of an annuity is: [1- 1/(1+r)^τ]/r.
present
