Chapter 5 TB

Question 1

The main idea behind the time value of money is that a dollar today is worth more than a dollar in the future because ________.

A) inflation erodes the value of money over time
B) investors can earn a return on money they have today and thereby have more money in the future
C) the future is more uncertain than the present
D) investors are impatient

Answer 1

B

Question 2

You invest a certain amount of money today. The process of determining how much money that investment will produce in the future is called ________.

A) discounting
B) compounding
C) present value
D) annuitizing the cash flow

Answer 2

B

Question 3

The process of taking cash flow that is received or paid in the future and stating that cash flow in present value terms is called discounting.

T or F?

Answer 3

TRUE

Question 4

A certain investment that costs $10,000 today promises to pay you $10,500 in five years. This investment ________.

A) is unambiguously a good investment
B) is unambiguously a bad investment
C) may be a good investment if the rate of return you can earn an alternative investments is very low
D) may be a good investment if the rate of return you can earn on alternative investments is very high

Answer 4

C

Question 5

Since individuals generally have opportunities to earn positive rates of return on their funds, the timing of cash flows does not have any significant economic consequences.

T or F?

Answer 5

FALSE

Question 6

The time value of money is based on the belief that a dollar that will be received at some future date is worth more than a dollar today.

T or F?

Answer 6

FALSE

Question 7

For any positive interest rate, the future value of $100 increases with the passage of time. Thus, the longer the period of time, the greater the future value.

T or F?

Answer 7

TRUE

Question 8

Future value is the value of a future amount at the present time, found by applying compound interest over a specified period of time.

T or F?

Answer 8

FALSE

Question 9

The greater the interest rate and the longer the period of time, the higher the present value.

T or F?

Answer 9

FALSE

Question 10

Everything else being equal, the higher the interest rate, the higher the future value.

T or F?

Answer 10

TRUE

Question 11

Future value increases with increases in the interest rate or the period of time funds are left on deposit.

T or F?

Answer 11

TRUE

Question 12

Everything else being equal, the higher the discount rate, the higher the present value

T or F?

Answer 12

FALSE

Question 13

Everything else being equal, the longer the period of time, the lower the present value.

T or F?

Answer 13

TRUE

Question 14

________ is the amount earned on a deposit that has become the part of the principal at the end of a specified time period.

A) Discount interest
B) Compound interest
C) Primary interest
D) Future value

Answer 14

B

Question 15

The amount of money that would have to be invested today at a given interest rate over a specified period in order to equal a future amount is called ________.

A) future value
B) present value
C) future value of an annuity
D) compounded value

Answer 15

B

Question 16

The future value of a dollar ________ as the interest rate increases and ________ the longer the money remains invested.

A) decreases; decreases
B) decreases; increases
C) increases; increases
D) increases; decreases

Answer 16

C

Question 17

The annual rate of return is referred to as the ________.

A) discount rate
B) marginal rate
C) risk-free rate
D) marginal cost

Answer 17

A

Question 18

An annuity due is a stream of equal cash flows with each cash flow arriving at the beginning of each period

T or F?

Answer 18

TRUE

Question 19

An ordinary annuity is an annuity in which cash flows occur at the beginning of each period.

T or F?

Answer 19

FALSE

An annuity due is an annuity in which cash flows occur at the beginning of each period.

Question 20

The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity for interest rates greater than zero.

T or F?

Answer 20

TRUE

Question 21

Which of the following is true of annuities?

A) An ordinary annuity is an equal payment paid or received at the beginning of each period.
B) An annuity due is a payment paid or received at the beginning of each period that increases by an equal amount each period.
C) An annuity due is an equal stream of cash flows that is paid or received at the beginning of each period.
D) An ordinary annuity is an equal payment paid or received at the end of each period that increases by an equal amount each period.

Answer 21

C

Question 22

An annuity with an infinite life is called a(n) ________.

A) perpetuity
B) primia
C) option
D) deep discount

Answer 22

A

Question 23

A(n) ________ is an annuity with an infinite life making continual annual payments.

A) amortized loan
B) principal
C) perpetuity
D) APR

Answer 23

C

Question 24

In comparing an ordinary annuity and an annuity due, which of the following is true?

A) The future value of an annuity due is always greater than the future value of an otherwise identical ordinary annuity.
B) The future value of an ordinary annuity is always greater than the future value of an otherwise identical annuity due.
C) The present value of an annuity due is always less than the future value of an otherwise identical ordinary annuity, since one less payment is received with an annuity due.
D) All things being equal, one would prefer to receive an ordinary annuity compared to an annuity due.

Answer 24

A

Question 25

The present value of a perpetual income stream increases when the discount rate ________. A) increases B) decreases C) changing unpredictably D) increasing proportionally

Answer 25

B

Question 26

The nominal (stated) annual rate is the rate of interest actually paid or earned. | T or F?

Answer 26

FALSE ## Footnote The effective annual rate is the rate of interest actually paid or earned.

Question 27

The nominal and effective rates are equivalent for annual compounding. | T or F?

Answer 27

TRUE

Question 28

The effective annual rate increases with increasing compounding frequency. | T or F?

Answer 28

TRUE

Question 29

The annual percentage rate (APR) is the nominal rate of interest, found by multiplying the periodic rate by the number of periods in one year. | T or F?

Answer 29

TRUE

Question 30

The annual percentage yield (APY) is the effective rate of interest that must be disclosed to customers by banks on their savings products as a result of "truth in savings laws." | T or F?

Answer 30

TRUE

Question 31

The effective rate of interest is the contractual rate of interest charged by a lender or promised by a borrower. | T or F?

Answer 31

FALSE ## Footnote The nominal rate of interest is the contractual rate of interest charged by a lender or promised by a borrower.

Question 32

The effective rate of interest differs from the nominal rate of interest in that it reflects the impact of compounding frequency. | T or F?

Answer 32

TRUE

Question 33

For any interest rate and for any period of time, the more frequently interest is compounded, the greater the amount of money that has to be invested today in order to accumulate a given future amount. | T or F?

Answer 33

FALSE

Question 34

The effective rate of interest and compounding frequency are inversely related. | T or F?

Answer 34

FALSE

Question 35

The rate of interest agreed upon contractually charged by a lender or promised by a borrower is the ________ interest rate. A) effective B) nominal C) discounted D) continuous

Answer 35

B

Question 36

The rate of interest actually paid or earned, also called the annual percentage rate (APR), is the ________ interest rate. A) effective B) nominal C) discounted D) continuous

Answer 36

A

Question 37

In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion of each payment declines over the life of the loan. | T or F?

Answer 37

TRUE

Question 38

In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment declines over the life of the loan, and the interest portion of each payment grows over the life of the loan. | T or F?

Answer 38

FALSE ##Footnote In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan and the interest portion of each payment declines over the life of the loan.

Question 39

In general, with an amortized loan, the payment amount remains constant over the life of the loan, both the principal portion of and the interest portion declines over the life of the loan. | T or F?

Answer 39

FALSE

Question 40

In general, with an amortized loan, the payment amount grows over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion declines over the life of the loan. | T or F?

Answer 40

FALSE ## Footnote In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan and the interest portion of each payment declines over the life of the loan.

Question 41

When computing an interest or growth rate, the rate will increase with an increase in future value, holding present value and the number of periods constant. | T or F?

Answer 41

TRUE

Question 42

When computing an interest or growth rate, the rate will decrease with an increase in future value, holding present value and the number of periods constant. | T or F?

Answer 42

FALSE

Question 43

When computing an interest or growth rate, the rate will increase with a decrease in future value, holding present value and the number of periods constant. | T or F?

Answer 43

FALSE

Question 44

When computing the number of deposits needed to accumulate to a future sum, it will take longer if the interest rate decreases, holding the future value and deposit size constant. | T or F?

Answer 44

TRUE

Question 45

When computing the number of deposits needed to accumulate a future sum, it will take longer if the interest rates are higher, holding the future value and deposit size constant. | T or F?

Answer 45

FALSE

Question 46

The time value concept/calculation used in amortizing a loan is ________. A) future value of a dollar B) future value of an annuity C) present value of a dollar D) present value of an annuity

Answer 46

D