FINC 409 Ch.

9
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1. amortized loan a loan repaid 6. Assume your bank has a choice between a. Account A
in equal two deposit accounts. Account A has an
payments annual percentage rate of 7.55% with
over a interest compounded month. Account B
specified time has an annual percentage rate 7.45% with
period interest compounded quarterly. Which
account provides the highest effective
2. annual percentage rate (APR) determined by
annual return?
multiplying
a. account A
the interest
b. account B
rate charged
c. both provide the same effective annual
per period by
return
the number of
d. we don't have enough information to
period in a
tell
year
7. The basic future and present value d. inflation rate
3. annuity a series of
equations contain 4 variables. Which of (I)
equal
the following is not included?
payments
a. present value (PV)
(receipts) that
b. future value (FV)
occur over a
c. interest rate (r)
number of
d. inflation rate (I)
time periods
e. number of periods (n)
4. annuity due exists when
8. compounding arithmetic
equal periodic
process
payments start
whereby an
at time period
initial value
zero or, in
increases or
other words,
grows at a
the beginning
compound
of each time
interest rate
period
over time to
5. Assume your bank has a choice between a. Account A reach a value in
two deposit accounts. Account A has an the future
annual percentage rate of 4.62% with
9. compounding interest involves earning
interest compounded monthly. Account B
interest on
has an annual percentage rate of 4.62% but
interest in
with interest compounded quarterly. Which
addition to
account provides the highest effective
interest on the
annual return?
principle or
a. Account A
initial
b. Account B
investment
c. Both provide the same effective annual
return 10. discounting arithmetic
d. We don't have enough information to process
make a choice whereby a
future value (FV)
decreases at a
compound
interest rate
over time to
reach a present
value (PV)
11. effective annual rate (EAR) measures the true 18. If the stated or nominal interest rate is 10% b. 6%
interest rate when and the inflation rate is 4%, the net or
compounding differential compounding rate would be ____ 10%-4%= 6%
occurs more %
frequently than a. 10
once a year b. 6
c. 4
12. A famous athlete is awarded a contract c present value of
d. 14
that stipulated equal payments to be an annuity
made monthly over a period of 5 years. 19. In future value or present problems, unless a. at the end
To determine the value of the contract states otherwise, cash flows are assumed to of a time
today, you would need to us: be period
a. present value of a single lump sum a. at the end of a time period
b. future value of a single lump sum b. at the beginning of a time period
c. present value of an annuity c. in the middle of a time period
d. future value of an annuity d. spread out evenly over a time period
13. future value value of a savings 20. Interest earned only on an investment's a. simple
amount or an principal or original amount is referred to interest
investment at a as:
specified time or a. simple interest
date in the future b. compound interest
c. discount interest
14. The future value of a dollar _____ as the c. increases;
d. annuity interest
interest rate increases and _____ the increases
farther in the future is the funds are to 21. The interest rate determined by multiplying a. annual
be received. the interest rate charged per period by the percentage
a. decreases; decreases number of periods in a year is called the: rate
b. decreases; increases a. annual percentage rate
c. increases; increases b. compound rate of interest
d. increases; decreases c. stated rate of interest
d. effective annual rate
15. If the APR is 12% and interest is c. 12.68%
compounded monthly, then the EAR is 22. The interest rate that measures the true d. effective
a. 12% monthly interest interest rate when compounding occurs annual rate
b. 1% rate = 12%/12 = 1% more frequently than once a year is called
c. 12.68% EAR= (1 + 1%)^12 - the:
d. none of the above 1 = 1.1268 - 1 = a. annual percentage rate
12.68% b. compound rate of interest
c. stated rate of interest
16. If the quarterly rate of interest is 2.5% a. 10.38%
d. effective annual rate
and interest is compounded quarterly,
then the EAR is EAR= (1 + 2.5%)^4 23. Larry deposited $5,000 in a savings account b. 8.24%
a. 10.38% - 1 = 1.1038-1 = that paid 8% interest compounded
b. 10% 10.38% quarterly. What is the effect rate of r is the
c. 2.5% interest? interest
d. 39.06% a. 8% charged per
b. 8.24% period
17. If the quarterly rate of interest is 2.5% b. 10%
c. 8.33% 8%
and interest is compounding quarterly,
d. 8.46% compounded
then the APR is APR= 2.5% * 4=
quarterly is
a. 10.38% 10%
2% per
b. 10%
quarter
c. 2.5%
d. 39.06%
24. loan amortization schedule
25. A loan that is repaid in
equal payments over a
specified time period is
called a(n)
a. discount loan
b. balloon loan
c. amortized loan
d. none of the above
26. The mot hod of calculating
interest on a loan that is set
by law is called the:
a. negotiated legal rate
(NLR)
b. effective annual rate
(EAR)
c. annual percentage rate
(APR)
d. none of the above
27. ordinary annuity
28. present value
29. rule of 72
30. A series of equal payments
or receipts that occur at the
beginning of each of a
number of time periods is
referred to as:
a. an ordinary annuity
b. a deferred annuity
c. an annuity due
d. an extraordinary annuity
31. simple interest
a schedule of the breakdown 32. Suppose you have a choice of 2 equally b. the annuity
of each payment between risky annuities, each paying $1,000 per due
interest and principal as well year for 20 years. One is an annuity
as the remaining balance due, while the other is an ordinary
after each payment annuity. Which annuity should you
choose?
c. amortized loan
a. the ordinary annuity
b. the annuity due
c. with one because the annuities have
the same present value
d. without information about the
appropriate interest rate, we cannot tell
which annuity is better
33. The time value concept/calculation used d. present value
c. annual percentage rate
in amortizing a loan is of an annuity
(APR)
a. future value of a dollar
b. future value of an annuity
c. present value of a dollar
d. present value of an annuity
34. time value of money math of finance
whereby a
financial return is
earned over time
by saving or
equal payments (receipts)
investing money
occur at the end of each time
period 35. T or F true
A fixed-rate mortgage is an example of
amount of value today of a
an annuity
savings or an investment
36. T or F true
a shortcut method used to
A loan amortization schedule shows the
approximate the time
breakdown of each payment between
required for an investment to
interest and principal, as well as the
double in value
remaining balance after each payment
c. an annuity due
37. T or F true
An amortized loan is repaid in equal
payments over a specified time period
38. T or F false
An annuity due may also be referred to
as a deferred annuity
39. T or F ture
An annuity is a series of equal payment
interest earned only on the that occur over a number of time
investment's principle periods
40. T or F false
An ordinary annuity exists when the they occur at the
equal payments occur at the beginning end of each time
of each time period period
41. T or F true
As the interest rate increases, present
value decreases
42. T or F false 54. T or F true
As the number of periods increases, present Level cash flow amounts that occur at ordinary annuity
value increases the end of each period, starting at the
end of the first period, are an annuity
43. T or F true
due
At a zero interest rate, the present value of
$1 remains at $1 and is not affected by time 55. T or F true
Money has a time value so long as
44. T or F false
interest is earned by saving or
At very high interest rates the "Rule of 72" same is
investing money
will result in a small estimation error for the true at
estimate of the time for an investment to very low 56. T or F false
double interest Simple interest is interest earned on simple interest
rates the investment's principal and does NOT earn
subsequently-earned interest interest on
45. T or F true
previously earned
At very low interest rates, the "Rule of 72"
interest
does not approximate the compounding
process well 57. T or F false
The annual percentage rate (APR)
46. T or F false
overstates the true or effective
Because interest compounds, the annual
interest cost
percentage rate formula will overstate the
true interest cost of a loan 58. T or F false
The annual percentage rate is the true EAR is
47. T or F true
opportunity cost measure of the
Compounding means that interest earned
interest rate
each year, plus the principal, will be
reinvested at the stated rate 59. T or F true
The effective annual rate (EAR) is
48. T or F true
sometimes called the annual effective
Compound interest is interest earned on
yield
interest in addition to interest earned on the
principal 60. T or F true
The effective annual rate (EAR) is the
49. T or F true
true opportunity cost measure of the
Discounting is an arithmetic process whereby
interest rate
a future sum decreases at a compounding
interest rate over time to reach a present 61. T or F false
value The effective annual rate is for EAR
determined by multiplying the
50. T or F false
interest rate charged per period by
For a given discount rate, an ordinary annuity
the number of periods in a year
and an annuity due have the same present
value 62. T or F false
The interest portion increases and the decreases,
51. T or F true
principal portion decreases over time increases
For the same annual percentage rate, more
under a typical loan amortization
frequent compounding increases the future
schedule
value of an investor's funds more quickly
63. T or F true
52. T or F true
The mot hod of calculating the annual
If the compound inflation rate were greater
percentage rate (APR) is set by law
than the compound interest rate, future
purchasing power on our savings would all 64. T or F true
The Rule of 72 is an estimate of how
53. T or F false
long it would take to double a sum of
If the interest rate is 0% for 10 years, then the it will be
money at a given interest rate
present value will be less than the future the same
value
65. T or F true 73. Which of the following characteristics is b. the same
When the annual interest rate stays the not descriptive of an amortization dollar amount of
same, more frequent interest schedule? interest is paid
compounding helps savers earn more a. each payment is the same with each
interest over the course of the year b. the same dollar amount of interest is payment
paid with each payment
66. T or F false
c. payment on principal increases with
With compound interest, interest is
each total payment
earned only on the investment's
d. balance owed is reduced by the
principal
principal portion of each payment
67. usury the act of
74. Which of the following statements is c. The effective
lending money
false? annual rate is
at an
a. For a given APR, more frequent determined by
excessively high
compounding results in additional return multiplying the
interest rate
on the investment interest rate
68. The ____ value of a savings or investment a. present b. An amortized loan is repaid in equal charged per
is its amount or value at the current time payments over a specified time period period by the
a. present c. The effective annual rate is number of
b. future determined by multiplying the interest periods in a year
c. book rate charged per period by the number
d. none of the above of periods in a year
69. What is the highest effective rate c. 12.72% d. Each of the above statements is true
attained with a 12% nominal rate? 75. Which of the following statements is d. for a given
a. 12% DAILY: (1 + false? APR, the present
b. 12.55% 12/365)^365 -1 = a. the present value of a sum decreases value of a future
c. 12.72% (1.0003288)^365 as the discount rate increases sum decreases at
d. 12.95% -1 = 12.72% b. If the present value of a sum is equal the number of
70. When compounding more than once a d. effective to its future value, the interest rate must discounting
year, the true opportunity costs measure annual rate be 0 periods per year
of the interest rate is indicated by the c. If the discount (or interest ) rate is decreases
a. annual percentage rate positive, the future value of an expected
b. contract rate series of payments will always exceed
c. stated rate the present value of the same series
d. effective annual rate d. For a give APR, the present value of a
future sum decreases as the number of
71. When solving for the future value of an c. 1 divided by
discounting periods per year decreases
amount deposited now, which one of the the sum of 1
following factors would not be part of plus the interest 76. Which of the following terms best c. payment at
the calculation? rate describes an annuity due? beginning of
a. present value amount a. decreasing payments year
b. 1 plus the interest rate b. increasing payments
c. 1 divided by the sum of 1 plus the c. payment at beginning of year
interest rate d. payment at the end of the year
d. number of periods to compound over 77. You need to have $35,000 on hand to a. present value
72. When the amount earned on a deposit b. discount buy a new Lexus 5 years from today To of a single lump
becoming part of the principal at the end interest achieve that goal, you want to know sum
of a period and can earn a return in how much you must invest today in a
future periods, this is called certificate of deposit guaranteed to
a. discount interest return you 3% per year. To help
b. compound interest determine how much to invest today,
c. primary interest you will use:
d. future value a. present value of a single lump sum
b. future value of a single lump sum
c. present value of an annuity
d. future value of an annuity
78. Your current bank is paying 6.25% simple interest rate. You can move your savings account to Harris Bank that pays b.
6.25% compounded annually or to First Chicago bank paying 6% compounded semi-annually. To maximize your return Harris
you would choose bank
a. your current bank
b. Harris Bank
c. First Chicago bank
d. you are indifferent, because the effective interest rate for all 3 banks is the same