Keen Finance 3101 Exam 1

True or False: A $1,000 par value bond with an annual coupon rate of 10% would pay $100 in interest every 6 months.

False coupon rate of 5%

True or False: Ceteris paribus, as the frequency of compounding decreases, the EAR will exceed theAPR by greater and greater amounts.

False increases

True or False: The EAR will always be greater than the APR.

False periodic rate is always greater than APR

True or False: We can find the nominal interest rate by dividing the default and maturity premiums from the sum of the real rate and inflation.

False subtracting, not dividing

True or False: Interest rates were high in the late 1970s and early 1980s because of unusually high default premiums.

False unusually low

What is the overriding goal of corporate financial management and what are 3 ways of describing this goal?

To maximize wealth of owners, take holders 1) maximize price of common stock 2) maximize market value of company equity 3)

T/F: A simple percent change represents a change as part of the old or earlier value.

True

T/F: FVs represent the amount that an earlier amount will grow into.

True

T/F: Given the amount needed at the beginning of the retirement​ period, the annual deposits needed during the working period can be found by solving for​ "PMT" in the FVA formula.

True

T/F: If the top of a fraction is unchanged and the bottom of a fraction decreases by​ 5%, then the value of the whole fraction would increase by approximately​ 5%

True

T/F: We can find the amount needed to pay off a​ fixed-rate fully amortized mortgage loan at any point in time by solving for the PV of the remaining payments.

True

T/F: We've discussed 3 different multiple cash flow patterns.

True

T/F: What is​ "discounted" from the FV is the interest part to arrive at the PV.

True

T/F: With compound​ interest, interest is earned every period on that​ period's starting amount.

True

T/F: ​ "PMT" in the PVA formula tells us the periodic mortgage payments for a​ fixed-rate fully amortized loan.

True

T/F:The working capital management area deals with how much of a​ firm's assets should be held in​ cash, inventory and accounts receivable.

True

True or False: In the period 1950 - 1999 changes in the inflation premium was the main factor causing nominal interest rates to change.

True

What are the 3 main determinants of stock prices and how does each affect the stock price?

1) future cash flows 2) timing of cash flows 3) risk

What are the 3 areas of corporate financial management decision making?

1. Capital Budgeting: choosing long-term investments to take on 2. Capital Structure: getting long-term financing to pay for investments 3. Working Capital Management: managing everyday activities of the firm

ceteris paribus

"holding everything else constant"

Par Value

The face value of a bond.

Coupon Interest Rate

the stated annual interest rate on a bond

What is the difference between simple and compound interest?

simple interest is only paid on principal, while compound interest is paid on the principal plus all of the interest that has previously been earned

What is the "Cycle of Money" between investors and a corporation?

the movement of money from lender to borrower and back again.

Why do we need to learn Time Value of Money (TVM) tools?

to understand a dollar in hand today is worth more than a dollar tomorrow (in the future)?

T/F: For​ fixed-rate fully amortized mortgage​ loans, more of the fixed payment goes towards principal as we approach the end of the loan term.

true

T/F: PVs are leftward on a time line and FVs are rightward on the time line

true

True or False: Capital losses always reduce the investor's rate of return.

true

True or False: Ceteris paribus, bond prices move in the same direction as their coupon rates.

true

True or False: If you own long-term zero-coupon bonds, you would hope that interest rates would decrease.

true

True or False: Prior to maturity, discount bonds always sell for less than par value.

true

T/F: According to the Order of​ Operations, exponents are applied before the expression in​ parentheses, and addition and subtraction are to be completed before multiplication and division.

False

T/F: Annuities are unequal cash flows that go on for a finite period of time.

False

T/F: Ceteris​ paribus, the FV and the number of periods are inversely related.

False

T/F: Compounding is the process used to find a PV

False

T/F: FVs are earlier values and PVs are later values

False

T/F: FVs represent what you need to invest later to have it grow into a specified earlier amount

False

T/F: For a given​ mean, a larger standard deviation means that actual returns that are far from the mean are less likely to occur.

False

T/F: In a Normal​ Distribution, there is a​ 68% chance that an actual return will exceed the average return plus one standard deviation.

False

T/F: The number of years it would take an investment to double is approximately equal to the annual interest rate divided 72.

False

True or False: The Fisher Effect illustrates the positive relationship between inflation and nominal interest rates.

true

True or False: The YTM on a discount bond will be above its coupon rate.

true

True or False: The penalty for spending before earning is the interest rate from the point of view of the borrower.

true

What are the 3 basic multiple cash flow patterns?

uneven stream, annuity, perpetuity

How do you solve for the PV and FV of an uneven stream?

use Ch. 3 lump sum formulas and add them up

What is the Rule of 72 and how is it used to solve for approximate values of r and n?

used to figure out the approximate number of years or approximate rate

T/F: The principal part of a fixed mortgage loan payment can be found by multiplying the periodic interest rate by the ending balance for a given period.

False

T/F: There are a total of 5 variables in the basic TVM​ lump-sum formulas.

False

T/F: The​ right-hand side variables in the discount rate formula represent the 3 key factors determining stock prices.

False

T/F: We can determine which​ "PMT" we're being asked to solve for by noting what the problem provides in terms of r and n.

False

T/F: When given the annual withdrawals desired during the retirement​ period, the FVA tells us the amount we should have accumulated by the time we begin the retirement period.

False

T/F: to change a decimal value to a percent, divide by 100

False

Perpetuity

A stream of equal payments at fixed intervals expected to continue forever.

amortization schedule

A table showing precisely how a loan will be repaid. It gives the required payment on each payment date and a breakdown of the payment, showing how much is interest and how much is repayment of principal.

Uneven Cash Flows

A series of cash flows where the amount varies from one period to the next.

Annuity

A series of equal payments at fixed intervals for a specified number of periods.

Discount Bond

A bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate

Amortized Loan

A loan that is repaid in equal payments over its life.

How do you solve for the price of a bond?

Bond Price (PB) = Coupon PMT [(1 - 1/(1 + r)^n) / r] + Par / (1 + r)^n

What is involved with discounting and compounding?

Discounting: the process of determining the present value of the amount to be received in the future Compounding: method is used to know the future value of present money.

How does the PV formula embody the 3 key factors determining stock prices?

FV reflects future cashflows n reflects timing r reflects risk

For lump sums, how do you solve for PV, FV, r and n?

FV=PV(1+r)^n

How do changes in the Right-Hand-Side variables affect PV and FV?

Future value has a positive correlation with PV, r, and n. Present value has a positive correlation with FV but a negative correlation with r and n

What are the 3 perspectives on the interest rate?

General: rental price of money lender: reward for not consuming money borrower: penalty for spending before earning

What is meant by the periodic interest rate, APR, frequency of compounding and EAR?

Periodic interest rate: interest rate for whatever period were talking about APR: annual percentage rate Frequency of Compounding: how often does the interest get charged or credited to an account EAR: rate you would have to earn in one year to match compound rate

What is the meaning of PV and FV?

Present value and future value

What are the 3 things that a time line shows

Present value, future value, and total elapsed time

Nominal Interesest Rate

The actual rate at which money will grow. Nominal rates are typically stated in loan agreements and quoted in financial markets. If prices in the economy are also growing due to inflation, the nominal interest rate does not represent the increase in purchasing power that will result from investing at the nominal rate.

real interest rate

The rate of growth of purchasing power after adjusting for inflation

Coupon Payment

The specified number of dollars of interest paid each year. Coupon payment = coupon rate * FV of bond

YTM

Yield to Maturity: the rate of return earned on a bond if it is held to maturity

Premium Bond

a bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate

What is meant by a "lump sum"?

a single payment made at a particular time

Zero Coupon Bonds

bonds that pay no annual interest but are sold at a discount below par, thus compensating investors in the form of capital appreciation

T/F: The goal of the corporate financial manager is to maximize the​ firm's market share.

false

T/F: the capital budgeting area deals with how the firm should be financed

false

True or False: If you purchase a $1,000 par value bond for $1,050 and hold it to maturity, you would experience a capital gain on the bond equal to 5-percent.

false

True or False: Premium bonds are always worth more than par value at maturity.

false

True or False: You can earn a higher return by purchasing zero-coupon bonds at a premium.

false

True or False: If you buy a bond at par and hold it to maturity, you will experience a capital gain.

false buy a bond at discount

True or False: At maturity, investors must repay a bond's par value to the lender.

false to the issuer

How do current interest rates compare to those in the late 1970s-early 1980s and what accounts for the difference?

inflation rates were much higher

What does the Fisher Effect show?

it shows the relationship between real and nominal interest rates and inflation R Nominal = R Real + R Inflation

What is meant by "Primary" and "Secondary" markets?

primary: when a company offers stock for the first time secondary: the reselling of stocks or bonds to another party (exp. New York Stock Exchange)