Keen Finance 3101 Exam 1 2021

How do the variables in the lump-sum PV formula line up with the 3 determinants of stock prices?

FV reflects future cashflowsn reflects timingr reflects risk

4. How do you solve for the PV and FV of an annuity?

FV= PMT x (1+ r)^n -1 /r

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

FV=PV(1+r)^n

True or​ False: 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

True or​ False: 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

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

TRUE

True or​ False: PVs are leftward on a time line and FVs are rightward on the time line.

TRUE

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

10. How do the various components of the fixed-payment loan amortization schedule change as the term of the loan progresses?

-In the beginning most of it goes toward interest. -More goes toward principal as ending balance goes down -The amount of fixed payment goes down, and amount going toward principal goes up

5. What do the time subscripts in the PVA and PVP formulas tell us?

-With Time subscripts, the answer using either formula will be as of one period before the first PMT. -You can see time period goes up by 1. Ex: Prob # Lets say you have perpetuity that first payment wont be made until 10 year out. $100 perpetuity will begin at the end of year 10 and last forever and interest rate is 5% PV= PMT/ R → 100/.05 = 2,000 as of end of year 9 What would value be today?PV= 2000 / (1 +.05) ^9 =

What are the 3 perspectives on the interest rate?

1) General: interest rate is rental price of money 2) Lenders and borrowers POV (point of view) - lenders : reward for postponing consumption - borrower : penalty for spending b4 earning Periodic interest rate, APR, frequency of compounding and EAR

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

1) future cash flows2) timing of cash flows3) risk

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

1. Capital Budgeting: choosing long-term investments to take on2. Capital Structure: getting long-term financing to pay for investments3. Working Capital Management: managing everyday activities of the firm

What are the 3 basic multiple cash flow patterns?

1. Uneven Stream 2. Perpetuities - equal cash flow- infinite 3. Annuities - equal cash flow- finite

7. How do you determine which of the 3 "PMTs" you need to solve for?

3 Diff Formulas with PMT: 1. Solving Perpetuity - will say cash flows go on forever or that its a consol 2. Solving PMT for FV- will want EARLIER amount 3. Solving PMT for PV- will want LATER amount

6. How do you solve for "PMT" in the 3 formulas in which it appears?

Annuity: Calc Value in Bracket and divide into PV or FVPV= PMT x (1- (1 +r)^n / r)PMT= PV / (1- (1 +r)^n / r) Perpetuity:PMT= PV x rr= PMT/ PV

9. How do you construct a loan amortization schedule?

Beg Balance: given PMT : solve this by PV annuity INT: solve by periodic int rate Principal End Balance: beg bal -princ.

What is involved with discounting and compounding?

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

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

FALSE

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

FALSE

True or​ False: 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

8. How do you solve for loan amounts and fixed payments for fully-amortized loans?

Fixed Payment Fully Amortized Loans: -PV of annuity - The loan amount is -PMT- fixed payment

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

11. How do you find the amount needed to fully pay off a fixed-payment fully-amortized loan?

Overall, Calculate PV of remaining payments.

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

PV= FV/ (1+r)^1 + FV/ (1+r)^2 +FV/ (1+r)^3 FV= PV (1+r)^n3 + PV (1+r)^n2 + PV (1+r)^n1 + PV (1+r)^n0

3. How do you solve for the PV of a perpetuity?

PV= PMT x (1- (1 +r)^n / r) PV= PMT/ r

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

True or​ False: 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: 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

True or​ False: What is​ "discounted" from the FV is the interest part to arrive at the PV.

TRUE

True or​ False: With compound​ interest, interest is earned every period on that​ period's starting amount.

TRUE

True or​ False: ​ "PMT" in the PVA formula tells us the periodic mortgage payments for a​ fixed-rate fully amortized loan.

TRUE

True or​ False: ​ We've discussed 3 different multiple cash flow patterns.

TRUE

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)

15. How do you solve for the YTM of a zero coupon bond?

YTM- discount rate(Par value / Price of Bond) ^ (1/n) -1

What is meant by a "lump sum"?

a single payment made at a particular time

7. 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 low - high - low - high

4. What is meant by real and nominal interest rates?

nominal - The interest rate composed of a real interest rate plus the inflation ratereal rate - The reward for waiting.

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

periodic interest rate = we take the advertised APR and divide it by the number of compounding periods per year APR: yearly rate that you earn by investing or the charge for borrowing EAR: The compounded rate of interest per year; It is the APR adjusted for compounding. frequency of compounding: number of compounding periods per year is twelve (monthly compounding), we will have m=12; if it is quarterly compounding, we will have m=4; and so on.

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)?

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

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

FALSE

True or​ False: A lump sum can be a​ one-time earlier but not a​ one-time later cash flow.

FALSE

True or​ False: Annuities are unequal cash flows that go on for a finite period of time.

FALSE

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

FALSE

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

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

FALSE

True or​ False: Ceteris​ paribus, the FV and the number of periods are inversely related.

FALSE

True or​ False: Compounding is the process used to find a PV.

FALSE

True or​ False: FVs are earlier values and PVs are later values.

FALSE

True or​ False: FVs represent what you need to invest later to have it grow into a specified earlier amount.

FALSE

True or​ False: For a given​ mean, a larger standard deviation means that actual returns that are far from the mean are less likely to occur.

FALSE

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

FALSE

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

FALSE

True or​ False: The capital budgeting area deals with how the firm should be financed.

FALSE

True or​ False: The goal of the corporate financial manager is to maximize the​ firm's market share.

FALSE

True or​ False: 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: There are a total of 5 variables in the basic TVM​ lump-sum formulas.

FALSE

True or​ False: The​ right-hand side variables in the discount rate formula represent the 3 key factors determining stock prices.

FALSE

True or​ False: To change a decimal value to a​ percent, divide by 100.

FALSE

True or​ False: 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

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

FALSE

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

FALSE

True or​ False: ​ "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

True or​ False: 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

Nominal interest rates are the sum of two major​ components: the real interest rate and the maturity premium.

FALSE

True or False​: 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

12. How do you solve for targeted savings by retirement and savings required to reach that target?

How much must I have accumulated before you → PV of Annuity Formula How much must I save or invest to achieve goal → FV of annuity Formula

True or​ False: Ceteris paribus​, as a debtor and for the same annual interest​ rate, you would prefer simple interest to compound interest.

TRUE

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

TRUE

True or​ False: FVs represent the amount that an earlier amount will grow into.

TRUE

That a company chooses a new product to introduce into the market is a capital budgeting ​decision, that a company chooses to sell a bond to finance the new product is a capital structure ​decision, and that a company sets production and inventory levels on the new product is a working capital management decision.

TRUE

The Fisher Effect is the relationship between three​ items: the nominal​ rate, the real​ rate, and inflation.

TRUE

True or​ False: A simple percent change represents a change as part of the old or earlier value.

TRUE

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

TRUE

6. How do you solve for each variable in the approximate Fisher Effect?

nominal rate = real rate + inflation

5. What does the Fisher Effect show?

real interest rate equals the nominal interest rate minus the expected inflation rate

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.