CHAPTER 5 How can you use the present value of an annuity concept to determine the price of a house you

can afford? Mortgages are typically for a large enough amount of money that borrowing is required to purchase a home. The amount that one can afford for a home is a function of their current state of wealth. Mortgages allow consumers to spread the expense of a home over a longer period, typically 15 or 30 years. This allows consumers to put a smaller portion of wealth into the home (for example, a 20% down payment) and borrow the balance over the life of the loan. Due to the effect of annuity compounding, the payments for such a long lived debt make the monthly payments of a manageable nature so that they can be paid from current income. Use the idea of compound interest to explain why EAR is larger than APR. The annual percentage rate does not take into account the frequency of interest compounding. Equation 5-8 illustrates the conversion from APR to EAR. The effective annual rate converts the annual percentage rate to a rate that can be compared to other annual rates.

The interest on your home mortgage is tax deductible. Why are the early years of the mortgage more helpful in reducing taxes than in the later years? Mortgage payments at the beginning of the amortization schedule are predominantly interest with little principal. In later years, interest payments decline and principal payments make up an ever increasing part of the payments. Thus, the tax deductible part (the interest payment) is larger in the beginning years

CHAPTER 6

Classify the following financial instruments as money market securities or capital market securities: a. Federal Funds money market security b. Common Stock capital market security c. Corporate Bonds capital market security d. Mortgages capital market security e. Negotiable Certificates of Deposit money market security f. U.S. Treasury Bills money market security g. U.S. Treasury Notes capital market security h. U.S. Treasury Bonds capital market security i. State and Government Bonds capital market security

What are the different types of financial institutions? Include a description of the main services offered by each. The different types of Commercial Banks: depository institutions whose major assets are loans and whose major liabilities are deposits. Commercial bank loans cover a broader range, including consumer, commercial, and real estate loans, than do loans from other depository institutions. Because they are larger and more likely to have access to public securities markets, commercial bank liabilities generally include more nondeposit sources of funds, such as subordinate notes and debentures, than do those of other depository institutions. Thrifts: depository institutions including savings associations, savings banks, and credit unions. Thrifts generally perform services similar to commercial banks, but they tend to concentrate their loans in one segment, such as real estate loans or consumer loans. Credit unions often operate on a not-for-profit basis for particular groups of individuals, such as a labor union or a particular companys employees. Insurance Companies: protect individuals and corporations (policyholders) from financially adverse events. Life insurance companies provide protection in the event of untimely death or illness, and help in planning retirement. Property casualty insurance protects against personal injury and liability due to accidents, theft, fire, and so on. Securities Firms and Investment Banks: underwrite securities and engage in related activities such as securities brokerage, securities trading, and making markets in which securities trade. Finance Companies: make loans to both individuals and businesses. Unlike depository institutions, finance companies do not accept deposits, but instead rely on short- and long-term debt for funding, and many of their loans are collateralized with some kind of durable good, such as washer/dryers, furniture, carpets and the like. Mutual Funds: pool many individuals and companies financial resources and invest those resources in diversified asset portfolios. Pension Funds: offer savings plans through which fund participants accumulate savings during their working years. Participants then withdraw their pension resources (which have presumably earned additional returns in the interim) during their retirement years. Funds originally invested in and accumulated in a pension fund are exempt from current taxation. Participants pay taxes on distributions taken after age 55, when their tax brackets are (presumably) lower

WHAT ARE THE SIX FACTORSTHAT DETERMINE the nominal interest rate on

Inflation . The real interest rate. Default risk. Liquidity risk. Special provisions regarding the use of funds raised by a particular security issuer. The security's term to maturity.

Determine

CHAPTER 7 Determine the interest payment for the following three bonds: 3 percent coupon corporate bond (paid semiannually), 4.25 percent coupon Treasury note, LG1 and a corporate zero coupon bond maturing in 10 years. (Assume a $1,000 par value.) 3 percent coupon corporate bond (paid semi-annually): 3.5% $1,000 = $17.50 4.25 percent coupon Treasury note: 4.25% $1,000 = $21.25 corporate zero coupon bond maturing in 10 years: 0% $1,000 = $0

A bond issued by IBM on December 1, 1996 is scheduled to mature on December 1, 2096. If today is December 2. 2013, what is this bonds time to maturity. December 1, 2096 mins December 2, 2013 = 83 years.

CHAPTER 8 As owners, what rights and advantages do shareholders obtain? They are able to participate in the economic growth of publicly traded firms without having to manage business entities directly. They have the right to residual cash flows of corporate profits and often receive some of these cash flows through dividends. In addition, shareholders vote on the members for board of directors and other proposals for the company. Shareholder capital losses are capped in that they can only lose their initial investment. Stocks are very liquid and investors can enjoy this liquidity in both their entrance into the stock market and their exit from it.

What are the differences between common stock and preferred stock? Common stock dividends change over time, hopefully increasing in the long-term. Preferred stock pays a constant dividend. Preferred stockholders have higher precedence for payment in the event of firm liquidation from bankruptcy. However, preferred stockholders do not have voting rights that common stock holders enjoy. Preferred stock prices fluctuate with market interest rates and behave like corporate bond prices. Common stock price changes with the value of the companys underlying business.

Under what conditions would the constant growth rate model not be appropriate? When the growth rate exceeds the discount rate, the constant growth rate model cannot be employed. It is also not appropriate when the growth rate cannot reasonably be expected to be constant into the future.