Mid Term #2

Question 1

In order to determine the future value of some lump sum, we must use the process of _________________.

Answer 1

Compounding

Question 2

If we were to receive some lump sum in the future and we wanted to determine the value of the lump sum in today’s dollars, we must _______________ this future cash flow.

Answer 2

Discount

Question 3

True or False: The discount rate consists of the risk free rate plus the risk premium.

Answer 3

True

Question 4

True or False: A dollar today is worth more than a dollar tomorrow.

Answer 4

True

Question 5

Would you rather have $100,000 today or $100,000 one year from today?

Answer 5

I’d rather have $100,000 today.

Question 6

Holding all else equal, the more discounting periods of a lump sum received in the future, the ______________ the present value of the lump sum.

Answer 6

Smaller

Question 7

The present value of a lump sum that will be received in the future will be ______________ if the interest rate is larger.

Answer 7

Smaller

Question 8

Holding all else equal, the future value of a lump sum will be ______________ if the interest rate is larger.

Answer 8

Larger

Question 9

Holding all else equal, the future value of a lump sum will be ______________ if the number of time periods is larger.

Answer 9

Larger

Question 10

Holding all else equal, the future value of a lump sum will be ______________ if the size of the lump sum is increased.

Answer 10

Larger

Question 11

Suppose you invested $15,000 today into an account that will pay 12% per year. What will the value of the account be in 40 years?

Answer 11

Correct Answer: $1,395,765

PV = -15000

PMT = 0
N = 40
I = 12%

Solve for FV = 1,395,764.56

Question 12

Suppose you invested $3,500 today into an account that will pay 15% per year. What will the value of the account be in 35 years?

Answer 12

Correct Answer: $466,114

PV = -3500

PMT = 0
N = 35
I = 15%

Solve for FV = 466,114.33

Question 13

Suppose you expect to obtain $1,250,000 in 25 years from today. If the discount rate is 12%, then the value of this $1,250,000 will be __________________ in today’s dollars.

Answer 13

Correct Answer: $73,529

FV = 1,250,000

N = 25
I = 12%
PMT = 0

Solve for PV = -73,529

Question 14

(Compound interest) What will be the FV of the following investment? (end mode)

Initial investment of $1,000 for 20 years at 7% compounded annually

Answer 14

Correct Answer: $3869.68

PV = -1000

N - 20

PMT = 0

I = 7%

Solve for FV= 3869.68

Question 15

(Compound value solving for i) At what annual rate would the following have to be invested?

$12,000 to grow to $25,000 in 13 years

Answer 15

Correct Answer: 5.81%

PV = -12000

FV = 25000

N = 13

PMT = 0

Solve for I = 5.81%

Question 16

(Compound value solving for i) At what annual rate would the following have to be invested?

$150,000 to grow to $300,000 in 30 years

Answer 16

Correct Answer: 2.34%

PV = -150,000

FV = 300000

N = 30

PMT = 0

Solve for I = 2.34%

Question 17

(Compound value solving for i) At what annual rate would the following have to be invested?

$1,000 to grow to $2,700 in 5 years

Answer 17

Correct Answer: 21.98%

PV = -1000

FV = 2700

N = 5

PMT = 0

Solve for I = 21.98%

Question 18

(Compound value solving for i) At what annual rate would the following have to be invested?

$25,000 to grow to $2,000,000 in 50 years

Answer 18

Correct Answer: 9.16%

PV = -25,000

FV = 2,000,000

N = 50

PMT = 0

Solve for I = 9.16%

Question 19

(Compound value solving for n) How many years will it take to get the following (round your answer to the nearest year):

$100,000 to become $1,000,000 at 7% compounded annually

Answer 19

Correct Answer: 34 years

PV = -100,000
FV = 1,000,000
I = 7%
PMT = 0

Solve for N = 34

Question 20

(Compound value solving for n) How many years will it take to get the following (round your answer to the nearest year):

$2,100 to become $5,200 at 12% compounded annually

Answer 20

Correct Answer: 8 years

PV = -2,100

FV = 5,200

I = 12%

Solve for N = 8

Question 21

(Present value) What is the present value of the following amount?

$100,000 received 45 years from now discounted at a rate of 3% annually

Answer 21

Correct Answer: $26,443.86

FV = 100,000

N = 45

I = 3%

Solve for PV = -26,443.86

Question 22

(Present value) What is the present value of the following amount?

$250,000 received 15 years from now discounted at a rate of 2.5% annually

Answer 22

Correct Answer: $172,616.39

FV = 250,000

N = 15

I = 2.5%

Solve for PV = 172,616.39

Question 23

(Present value) What is the present value of the following amount?

$1,000,000 received 35 years from now discounted at a rate of 3.5% annually

Answer 23

Correct Answer: $299,976.86

FV = 1,000,000

N = 35

I = 3.5%

Solve for PV = -299,976.86

Question 24

(Present value) What is the present value of the following amount?

$2,500,000 received 55 years from now discounted at a rate of 4% annually

Answer 24

Correct Answer: $289,138.78

FV = 2,500,000

N = 55

I = 4%

PV = -2,500,000

Question 25

(Compound value) Amelia just received her annual performance bonus at her job of $15,000. She decides to put it in a savings account at her local bank which pays a 2% annual yield. How much money will she have accrued after 15 years?

Answer 25

Correct Answer: $20,188.03 PV = -15,000 I = 2% N = 15 Solve for FV = 20,188.03

Question 26

(Compound value) Amelia just received her annual performance bonus at her job of $15,000. She decides to put it in a Certificate of Deposit (CD) that would receive a yield of 5% annually. How much money will she have accrued after 15 years?

Answer 26

Correct Answer: $31,183.92 PV = -15,000 I = 5% N = 15 Solve for FV = 31,183.92

Question 27

Suppose that today, you invested $100,000 into a certificate of deposit that pays 5% per year. How much would your investment be worth 4 years from today?

Answer 27

Correct Answer: $121,550.63 PV = -100,000 I/Y = 5% N = 4 PMT = 0 Solve for FV = $121,550.63

Question 28

How much would your $100,000 investment be worth one year from today? Assume the account the money is invested in has a 5% annual return.

Answer 28

Correct Answer: $105,000 PV = -100,000 I/Y = 5% N = 1 PMT = 0 Solve for FV = $105,000

Question 29

Suppose you plan to receive $50,000 ten years from today, if the appropriate discount rate is 10%, what is the present value of $50,000?

Answer 29

Correct Answer: $19,277.17 FV = -50,000 I/Y = 10% N = 10 PMT = 0 Solve for PV = $19,277.17

Question 30

Suppose you plan to receive $50,000 ten years from today, if the appropriate discount rate is 25%, what is the present value of $50,000?

Answer 30

Correct Answer: $5,368,71 FV = -50,000 I/Y = 25% N = 10 PMT = 0 Solve for PV = $5,368.71

Question 31

Suppose you can afford to invest $1,000 each month into an account that pays 12% per year. How many years will you need to make this monthly investment for your account to be worth $1,000,000? (Assume the first investment will begin one month from today)

Answer 31

Correct Answer: 20.08 years Inputs: PV = 0 FV = 1,000,000 PMT = -1,000 I = 12%/12 = 1% The present value is 0 since there is no lump sum. FV is 1,000,000 since that is the amount you will receive at the end of N-year periods as a lump sum. PMT is -1,000 since it is annuity and cash outflow from your hand to the account. I is 1% since the annual rate is 12% and compounded monthly, thus 12%/12 = 1%. Solve for N = 240.98 As you put PMT and I as monthly rate, you find N as months. In other words, it will take 240.98 months to build up to $1,000,000 if you invest $1,000 a month at the monthly rate of 1%. In order to find the number of years, you divide N by 12, so 240.98/12 = 20.08 years.

Question 32

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 12%. What will be the value of the retirement account if you plan to retire in 30 years? (Assume the retirement account has a zero balance currently.)

Answer 32

Correct Answer: $1,206,663.42 Inputs: PV = 0 PMT = -5,000 I/Y = 12% N = 30

Question 33

A bank recently quoted you an annual interest rate of 5% on an automobile loan for a new sedan that is currently priced at $28,950. If the length of the loan is 6 years (or 72 months), what will your monthly payment be?

Answer 33

Correct Answer: $466.24 PV = $28,950 FV = 0 I/Y = 5%/12 months = .4167% per month N = 72 PV is 28,950 because that is how much you borrowed (cash inflow) to purchase a car. FV is 0 since you should be paid back after 6-year payments. I is 0.4167% since 5% is the annual rate and payment is monthly, so you divide 5% by 12. N is 72 since 6 years monthly payment, so 6 times 12. Compute PMT = -466.24 or $466.24 per month.

Question 34

If current automobile loans have a 5% annual interest rate on 6 years, and you can only afford a $230 monthly payment, how much of an automobile can you afford?

Answer 34

Correct Answer: $14,281.34 FV = 0 PMT = -230 N = 6X12 = 72 I = 5%/12 = 0.4167%

Question 35

What is the effective yield (as a decimal) on the automobile loans with an annual interest rate of 5% that compounds monthly?

Answer 35

Correct Answer: 5.12% Effective Yield = (1 + (i / m))m - 1, where i is annual rate, m is # of compounding per year. Effective Yield = (1 + (.05 / 12))12 - 1 = (1 + .004167)12 - 1 = .0512 or 5.12%

Question 36

If you were to begin investing $5,000 each year, beginning one year from today, into an account that paid 15% per year, then how much will the account be worth after 35 years?

Answer 36

Correct Answer: $4,405,851 Inputs: PV = 0 PMT = -5,000 N = 35 I = 15% Solve for FV = 4,405,851

Question 37

At what discount rate, will the present value of a $10,000 ordinary annuity payment for 5 years be worth $35,000 today?

Answer 37

Correct Answer: 13.20% Inputs: PV = -35,000 FV = 0 N = 5 PMT = 10,000 Solve for I = 13.20%

Question 38

If you were to invest $10,000 each year for the next 20 years, then what rate of return is required for your investment to be worth $1,000,000? (Assume the first payment will begin one year from today)

Answer 38

Correct Answer: 14.80% Input the following values: PV FV PMT N 0 1000000 -10000 20 After inputting these values, solve for I I = 14.80%

Question 39

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 12%. What will be the value of the retirement account if you plan to retire in 40 years? (Assume the retirement account has a zero balance currently.)

Answer 39

Correct Answer: $3,835,457.10 Inputs: PV = 0 PMT = -5,000 I/Y = 12% N = 40

Question 40

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 15%. What will be the value of the retirement account if you plan to retire in 30 years? (Assume the retirement account has a zero balance currently.)

Answer 40

Correct Answer: $2,173,725.73 Inputs: PV = 0 PMT = -5,000 I/Y = 15% N = 30

Question 41

What is the present value of a 10-year $5,000 annuity due if the discount rate is 10%?

Answer 41

Correct Answer: $33,795.12 For an annuity due the first payment is made at the beginning of the period or at the beginning of the first year. If we solve this problem using method two from the text we would first put the calculator in BEG MODE. Enter the following entries while solving for the present value. FV = 0 PMT = 5,000 N = 10 I =10% FV is 0 since there is no lump sum received or paid. PMT is 5,000 since it is annuity. I is 10% since it is the discount rate. N is 10 since you have payments of 5,000 for 10 years. Compute PV = -$33,795.12

Question 42

What is the present value of following streams of future cash flows if the discount rate is 11%? Year 1 Year 2 Year 3 $14,000 $16,540 $19,889

Answer 42

Correct Answer: $40,580 N(Year) 1 2 3FV 14,000 16,540 19,889I 11% 11% 11%PMT 0 0 0PV($12,612.61) ($13,424.24) ($14,542.67) For this problem, you have to discount future cash flows one by one. Therefore, each cash flow will be FV on your calculator. N is the year(s) you receive the cash flows. I is 11% which is your discount rate. PMT is 0 since there is no annuity. You compute PV's of each FV. In order to find the PV of the cash flows, you add the PV's of each cash flow. PV = 12,612.61 + 13,424.24 + 14,542.67 = $40,579.52

Question 43

What is the present value of following streams of future cash flows given at the end of each year if the discount rate is 15%? Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 $0 $0 $0 $21,000 $21,000 $21,000 $21,000

Answer 43

Correct Answer: $39,421 Step 1: With the end mode on your calculator: FV = 0 PMT = 21,000 I = 15% N = 4 FV is 0 since there is no additional lump sum at the end of Year 7 besides the annuity. PMT is 21,000 since 21,000 is an annuity. N = 4 since there are 4 payments of 21,000. I is 15% which is the discount rate. PV = -$59,954.5456 The present value you calculated with the first step is the value of the 4-year annuity of $21,000 discounted to at the end of Year 3. When you use End Mode on your calculator, the present value of annuities is a discounted value of the annuity back to one period before the first payment is made. In order to find the real present value (at Year 0), you need to discount the value you found in Step 1 for 3 more years. FV = 59,954.5456 N = 3 I = 15% PMT = 0 Solve: PV = $39,421.09

Question 44

What is the present value of the following stream of cash flows if the discount rate is 9%? Year 1 - $0 Year 2 - $0 Year 3 - $19,800 Year 4 - $16,840 Year 5 - $12,120

Answer 44

Correct Answer: $35,096.28 N (Year) 3 4 5 FV 19,800 16,840 12,120 I 9% 9% 9% PMT 0 0 0 PV (15,289.23) (11,929.88) (7,877.17) For this problem, you have to discount future cash flows one by one. Therefore, each cash flow will be FV on your calculator. N is the year(s) you receive the cash flows. I is 9% which is your discount rate. PMT is 0 since there is no annuity. You compute PV's of each FV. In order to find the PV of the cash flows, you add the PV's of each cash flow. PV = 15,289.23+11,929.88+7,877.17 = $35,096.28

Question 45

If you are going to receive $70,000 for 20 years starting 5 years from now, what is the present value of the cash flows discounted at 12%?

Answer 45

Correct Answer: $332,288 Step 1: End Mode N = 20 I = 12% PMT = $70000 FV = 0 PV = ? = $522,861.05 N is 20 since you have 20 payments, I is 12% which is the discount rate, PMT is $70,000 since that is the annuity, FV is 0 since there is no lump sum. Then solve for PV which is $522,861.05. Now if you use End mode, then PV you calculate on your calculator is one year before the first payment of the annuity is given. Since the annuity starts in 5 years, PV you calculate is in 4 years; thus you have to discount 4 more years with the PV you calculated as the FV. Step 2: FV = $522,861.05 N = 4 I = 12% PMT = 0 PV = ? = $332,287.65

Question 46

What is the today’s value of a $5,000 annual perpetuity starting in 40 years discounted at 8%?

Answer 46

Correct Answer: $3,107.09 Step 1: Value of Perpetuity at the beginning of year 40 = PMT/I = 5,000/0.08 = 62500 The perpetuity formula calculates discounted perpetuity back to a year before the first payment is given. Therefore, you have to discount what you find in the first step back by 39 years not 40 years. Step 2: FV = 62500 I = 8% N = 39 PMT = 0 PV = 3,107.09

Question 47

Suppose today is January 1st, and you have planned to invest $12,000 at the end of this year, $14,220 at the end of the second year, and $15,600 at the end of the third year. If you can earn a 14% rate of return in each year, what is the future value of this stream of cash flows at the end of 4 years?

Answer 47

FV = PV × (1 + i)n Year CFs FV 1 $12,000 $17,778.53 *Compound 3 years 2 $14,220 $18,480.31 *Compound 2 years 3 $15,600 $17,784.00 *Compound 1 year Sum of FVs $54,042.84

Question 48

What is the present value of an annual payment of $10,000 that is received in perpetuity if the discount rate is 13%?

Answer 48

Correct Answer: $76,923 When solving for the present value of a regular perpetuity we would use the formula PV = PMT/I 10,000/0.13 = $76,923

Question 49

Suppose that an investment product pays an investor $10,000 in perpetuity. If the appropriate discount rate is 12%, what should the price (or present value) of this product be?

Answer 49

Correct Answer: $83,333.33 PV (of a perpetuity) = CF/discount rate = $10,000/.12 = $83,333.33

Question 50

A particular investment product pays an investor 5 equal payments of $15,000 in each year, however the first payment starts immediately. If the appropriate discount rate is 10%, what is the price (or present value) of this annuity due?

Answer 50

Correct Answer: $62,547.98 The investor will receive an immediate cash flow of $15,000 (in time 0), and then $15,000 1 year from today, 2 years from today, 3 years from today, and 4 years from today. First, let’s calculate the present value of the future cash flows: FV = 0 I/Y = 10% N = 4 PMT = -$15,000 Compute PV = $47,547.98 Now add the present value of the $15,000 (which is $15,000 ) that will be received immediately to the present value of the future cash flows: $15,000+$47,547.98 = $62,547.98 Alternative method: Change calculator from end mode to beg. mode. Now, your calculator assumes the first payment is immediately received. Solve for PV FV = 0 I/Y = 10% N = 5 PMT = -15,000 Compute PV = 62,547.98

Question 51

What is the present value of the following stream of cash flows if the discount rate is 9%? Year 1 - $15,500 Year 2 - $17,250 Year 3 - $19,800 Year 4 - $16,840 Year 5 - $12,120

Answer 51

PV = (15,500 / 1.091) + (17,250 / 1.092) + (19,800 / 1.093) + (16,840 / 1.094) + (12,120 / 1.095) = 14,220.18 + 14,518.98 + 15,289.23 + 11,929.88 + 7,877.17 = $63,835.44

Question 52

MINI-CASE Name: April Current age: 25 Tax rate: 20% Assumed portfolio return: 8% annually Projected retirement age: 65 April nest-egg goal: $3,000,000 Calculate the required monthly savings that April needs to have in order to reach her goal to accumulate $3,000,000 when she retires if she makes payment at the end of each month until she retires?

Answer 52

Correct Answer: $859.35 First, find the number of years April has to save. Age of retirement - Current age = 65 - 25 = 40 FV = 3,000,000 N= 40 X 12 = 480 I = 8/12 = .6667 Solve for PMT = (859.35) N is going to be 40 years X 12 months. I is going to be 8/12 = .6667

Question 53

MINI-CASE Name: April Current age: 25 Tax rate: 20% Assumed portfolio return: 8% annually Projected retirement age: 65 April nest-egg goal: $3,000,000 Calculate the required monthly savings April needs to have to reach her goal if she starts saving at age 35?

Answer 53

Correct Answer: $2,012.94 Number of years April will save = 65 - 35 = 30 Calculator: FV = 3,000,000 I = 8/12 = .667 N = 30 X 12 = 360 Solve for PMT = (2,012.94)

Question 54

MINI-CASE Name: April Current age: 25 Tax rate: 20% Assumed portfolio return: 8% annually Projected retirement age: 65 April nest-egg goal: $3,000,000 Calculate the required monthly savings April needs to have to reach her goal if she starts saving at age 50?

Answer 54

Correct Answer: $8,669.56 Years of saving = Retirement Age - Age she will start saving Years of saving = 65 - 50 = 15 FV = 3,000,000 N = 15 X 12 = 180 I = 8/12 = .667 Solve for PMT = (8,669.56)

Question 55

Lisa is putting together a retirement plan and is scheduled to retire in 32 years. She is planning to open a retirement account and invest an equal amount each month into the retirement account. If she expects to earn 9% per year in the account and is planning to have $2,000,000 in the account at retirement, what is the amount of the monthly investment?

Answer 55

Correct Answer: $902.32 PV = 0 FV = 2000000 N = 32 X 12 = 384 I = 9/12 = .75 Solve for PMT = ($902.32)

Question 56

Blake is planning to retire in 38 years. He is thinking about opening a retirement account and plans to invest an equal amount each year into the account. He expects to earn 13% per year in the account and is planning to have $1,750,000 in the account at retirement, what is the amount of Blake’s annual investment?

Answer 56

Correct Answer: $2,209 PV = 0 FV = 1750000 N = 38 I = 13 Solve for PMT = ($2,209.01)

Question 57

(Loan amortization) The Jones family recently purchased a new home for $2,300,000. The family paid $250,000 down at signing and decided to pay the rest over 15 years in equal monthly payments that include principal payments plus 4.5% interest on the unpaid balance. Determine the amount of the equal monthly payments the Jones family will have to make over the life of the loan?

Answer 57

Correct Answer: $15,682.36 PV = 2,300,000 - 250,000 = 2,050,000 N = 15 X 12 = 180 I = 4.5/12 = .375 Solve for PMT = (15,682.36)

Question 58

(Solving for Annuity) Mary and John had their first child a week ago. They decide to set up a savings account for their child’s college education in 18 years. Mary figures that tuition costs for her child to get a 4-year degree at the local university at the end of 18 years will be $40,000. At their local bank, they can offer an account with 3% annual yield. How much will Mary and John have to pay at the end of each month to attain their goal?

Answer 58

Correct Answer: $139.89 FV = 40,000 PV = 0 I = 3/12 = .25 N = 18 X 12 = 216 Solve for PMT = (139.89)

Question 59

(Present value of an ordinary annuity) In the month of December, you receive a job offer from Credit Suisse. The letter tells you that you will be starting on January 1st, and you will receive an annual salary to be paid at the end of each year of $70,000. The letter also says that this is a 4-year contract after which you will be expected to do an MBA. Before accepting you decide to calculate the present value of your 4-year contract with Credit Suisse as of your starting date. What is your contract worth at that time given a 15% discount rate?

Answer 59

Correct Answer: $199,848.48 PMT = 70,000 N = 4 I = 15% Solve for PV = (199,848.49)

Question 60

If you are compounding a cash flow, you are:

Answer 60

Finding a future value

Question 61

Today, a round-trip plane ticket from Los Angeles to New York costs $350. If the average annual inflation rate is 2.5%, who much will the ticket cost 30 years from now?

Answer 61

$734.15

Question 62

You want $15,000, fifteen years from now. If you can earn 8% per year in your savings account, how much do you have to deposit in today?

Answer 62

$4,729

Question 63

Which of the following best describes the difference between an annuity due and an ordinary annuity?

Answer 63

An ordinary annuity pays at the end of the period, but an annuity due pays at the beginning.

Question 64

You are planning to retire 40 years from now. If your retirement account pays an annual rate of 6% compounded monthly and you start making a monthly contribution of $400 a month today, how much will you have when you retire in 40 years?

Answer 64

$800,579

Question 65

If you deposit $10,000 in an account with annual rate of 9% compounded semi-annually, how long will it take for you to have $2,000,000 in the account?

Answer 65

60.18 years

Question 66

Suppose you deposit $10,000 in an account today that pays an interest rate which is compounding monthly. If your goal is to have $2,000,000 in 40 years, the stated annual rate must be at least:

Answer 66

13.32%

Question 67

Which of the following gives the smallest effective yield? Assume that 1 year is 365 days.

Answer 67

18.65% APR compounded monthly

Question 68

How does a perpetuity differ from an ordinary annuity?

Answer 68

A perpetuity has payments that go on forever while an ordinary annuity has a limited numbers of cash flows.

Question 69

Suppose you want to establish a fund that will pay $5,000 a year forever to your favorite charity. If the discount rate is 8%, how much do you have to set a side today?

Answer 69

$62,500

Question 70

You have a son who is 5 years old. You want to provide financial help when he goes to college in exactly 13 years. You are planning to give him $20,000 a year at the beginning of each year for 4 years to pay his educational expenses. How much do you have to set aside today if you can earn an annual rate of 5% on all invested funds?

Answer 70

$39,490

Question 71

What is the value of an asset that pays $5,000 at the end of each of the next three years, $7,500 at the end of each of the following three years, and $10,000 at the end of each of the final three years? Assume a discount rate of 7%.

Answer 71

$46,675

Question 72

What should you be willing to pay now in order to receive $12,000 annually forever starting 40 years from now if you require 8.5% on the investment?

Answer 72

$5,861

Question 73

You bought a new car today which cost you $20,000. You financed the entire cost with a 5-year loan at 4.00%. If you make payments at the end of each month starting a month from now, how much is your monthly payment?

Answer 73

$368.33

Question 74

4 years ago you took out a student loan of $20,000 with the annual interest rate of 8% compounded monthly. Because it is a student loan, you did not make any payments while you were in school but interest was still accruing on the amount borrowed. You just graduated. As such, you must now start paying back your loan by making equal, monthly, end of the month payments. If you plan to pay back the loan over the next 10 years, how much is your monthly payment?

Answer 74

$333.81

Question 75

You just started a full-time job today and received information on the firm’s retirement savings program. Your employer will match all your contributions on a 1-to-1 basis and you expect an average annual return of 6%. You decided to make a monthly contribution to your retirement account of $315 at the beginning of each month starting today. How much will you have in 40 years?

Answer 75

$1,260,912

Question 76

You are considering buying a house. Your current annual salary is $100,000 and you want the monthly payment to be no more than 25% of your monthly income. You can get 25-year mortgage at 4.2% APR. Insurance and taxes will be $300 per month and must be included when calculating your maximum loan amount. If you can make a down payment of $30,000, what is the maximum amount you can spend on a house?

Answer 76

$360,895

Question 77

You just welcomed a new baby girl to your family today. You want your daughter to go to Harvard in 18 years for her college education. This year, tuition and fee are $60,000 if she were attending today. You expect the cost to increase by 4% each year. Assume the full amount is payable at the beginning of each year. Your savings account earns an annual rate of 6% but is compounded monthly. What will be the cost of attending for one year when she starts college in 18 years?

Answer 77

$121,549

Question 78

You just welcomed a new baby girl to your family today. You want your daughter to go to Harvard in 18 years for her college education (assumed to be 4 years in length). This year, tuition and fees are $60,000 IF she were attending today. You expect the cost to increase by 4% each year. Assume the full amount is payable at the beginning of each year. Your savings account earns an annual rate of 6% but is compounded monthly. (Challenge Problem) If you are going to make a monthly deposit at the beginning of each month starting a month from today until the first month your daughter starts college in 18 years, how much do you have to put in every month?

Answer 78

$1,217

Question 79

True or False: Bonds are the backbone of the world's pension funds.

Answer 79

True

Question 80

True or false: The two main reasons the text states for the importance of understanding bonds are the bond market is an important source of financing and bonds play a role in most personal investment plans.

Answer 80

True

Question 81

True or false: Bonds are also known as "fixed income."

Answer 81

True

Question 82

In the bond market, firms raise debt financing directly from ________.

Answer 82

Investors

Question 83

Bookmark question for later What is the written agreement between the bond issuer and its bondholders called?

Answer 83

Indenture

Question 84

The period of time for which a bond remains outstanding is called:

Answer 84

Maturity

Question 85

The stated interest payment made on a bond is the:

Answer 85

Coupon

Question 86

Which of the following types of loans are always classified as a secured loan?

Answer 86

Credit Card and Mortgage

Question 87

BLU-DAY Co. is currently issuing a $1,000 face-value bond that has an annual coupon of 6% and matures in 10 years. Interest payments are made annually. If the yield to maturity is 8%, then what is the current price of the bond?

Answer 87

Correct Answer: $865.80 PV FV PMT N I ($865.80) 1000 60 10 8%

Question 88

LLY Corporation is planning to issue a $1,000 face value bond with a maturity of 30 years. The annual coupon rate is expected to be 7.25% and interest payments are expected to be paid semi-annually. If the market is requiring a return of 10% annually on similar bonds, then what should LLY expect to receive for each bond they issue?

Answer 88

Correct Answer: $739.72 PV FV PMT N I ($739.72) 1000 36.25 60 5%

Question 89

The Diamond Co. just issued some new bonds with a maturity of 15 years and a face value of $1,000. Similar bonds have an annual coupon rate of 8.5%, and a yield to maturity of 7.2%. What is the current price of these bonds?

Answer 89

Correct Answer: $1,116.92 FV = $1,000 PMT = $85 N = 15 I/Y = 7.2% Compute PV = -$1,116.92

Question 90

(Bond valuation) Tonic Juice Corp.’s 15-year, $1,000 par value bonds pay 12% interest annually. The market price of the bonds is $1,062.20 and your required rate of return is 10%. Determine the value of the bond to you given your required rate of return. Should you purchase this bond?

Answer 90

Correct Answer: You should buy the bond since the actual price of the bond is lower than the price with your required rate. Price of the bond with the required rate of return: PV FV PMT N I ($1,152.12) $1,000.00 120 15 10% Given your required rate of return, you would value the bond to be worth $1,152.12 today. Since the market price of this bond is below this price, this means the bond is traded cheaper than you believe it should; therefore you should buy it to get a higher return than you require.

Question 91

Current Government Treasury bills (i.e. short-term bonds) are priced at 96.8% of par, where par is $1,000. If these bonds do not pay a coupon and mature in one year from today, then what is the yield to maturity on these bonds?

Answer 91

PV FV PMT N I -968 1000 0 1 3.31%

Question 92

A 7.5 percent semi-annual coupon bond is priced at $1,055.33. The bond has a $1,000 face value and an annual yield to maturity of 6.5 percent. How many years until this bond’s maturity?

Answer 92

Correct Answer: 6.97 years FV = $1,000 PMT = $75/2 = $37.50 PV = -$1,055.33 I/Y = 6.5%/2 = 3.25% Compute N = 13.94 (this is in semi-annual time periods) = 13.94/2 = 6.97 years

Question 93

A bond for AJB Co. has a yield to maturity of 13.90 percent, a 9.5 percent annual coupon, a $1,000 face value, and a maturity date 5 years from today. What is the current yield?

Answer 93

Correct Answer: 11.20% First, let’s find that price of the bond: FV = $1,000 PMT = $95 I/Y = 13.9% N = 5 Compute PV = -$848.58 With the current price of $848.58, we can now solve for the current yield. Recall that: Current Yield = Annual Coupon/Current Market Price of Bond. = 95/848.58 = 0.112 or 11.2%

Question 94

(Bondholder’s expected rate of return) Jobby McJobberton’s Inc. is selling bonds for $700. It has an 8% coupon rate and makes payments semi-annually. The bond matures in 25 years. What is the bond’s expected rate of return?

Answer 94

Correct Answer: 11.74% PV FV PMT N I ($700.00) $1,000.00 40 50 5.87% 5.87% X 2 = 11.74%

Question 95

(Bond valuation) Tonic Juice Corp.’s 15-year, $1,000 par value bonds pay 12% interest annually. The market price of the bonds is $1,062.20 and your required rate of return is 10%. Compute the bond's market expected rate of return.

Answer 95

Correct Answer: 11.13% PV FV PMT N I $ (1,062.20) $ 1,000.00 120 15 11.13%

Question 96

What are bonds issued by cities, counties, or states called?

Answer 96

Municipal Bonds

Question 97

What is a bond called that has no coupon payments?

Answer 97

Zero Bonds

Question 98

A zero-coupon bond that is currently priced at $456, has a face value of $1,000, and matures in 10 years. What is the yield to maturity of this bond?

Answer 98

Correct Answer: 8.17% FV = -1,000, PV = $456, PMT = 0, N = 10, Compute I/Y = 8.17%

Question 99

What is a bond that is unsecured called?

Answer 99

Debentures

Question 100

Suppose you bought a 10-year $1,000 face-value bond for $925 one year ago. The annual coupon rate is 7% and interest payments are paid annually. If the price today is $1,004, the yield to maturity must have changed from _____________ to ______________.

Answer 100

Correct Answer: 8.12%; 6.94% PV FV PMT N I -925 1000 70 10 8.12% -1004 1000 70 9 6.94%

Question 101

If returns required by bondholders have increased 1.5% from last year, we should expect bond prices to have _______________.

Answer 101

Decreased

Question 102

The relation between bond prices and yields to maturity can best be described as:

Answer 102

Inverse

Question 103

Stockholders have a __________ claim on firm earnings and assets.

Answer 103

Residual

Question 104

True or False: A right that common stock shareholders have is the right to vote on company management and policy.

Answer 104

True

Question 105

True or false: Knowing about equity is only important if you want to become a Wall Street banker.

Answer 105

False

Question 106

True or false: Equity often is a big part of individual investment portfolios.

Answer 106

True

Question 107

Which of the following securities is considered a hybrid security?

Answer 107

Preferred stock

Question 108

If a company skips a dividend payment to preferred shareholders, then the company _____________.

Answer 108

Cannot pay any dividends to common shareholders until the preferred dividend is paid

Question 109

Which of the following securities represents ownership in the firm?

Answer 109

Any sort of stock like common or preferred

Question 110

Which of the following statements is correct regarding preferred stock and the common stock?

Answer 110

Both preferred and common stocks do not have fixed maturities like bonds.

Question 111

Corporate Governance can be defined as:

Answer 111

The rules and regulations for managers of the firm

Question 112

A preferred stock pays a dividend of $1.79 in perpetuity. If the return required by shareholders is 8%, then the price per share for this preferred stock is:

Answer 112

Correct Answer: $22.38 Price = 1.79/0.08 = $22.38

Question 113

If a preferred stock pays a constant dividend of 5% of par, which is $50, and investors require a rate of return of 9%, what is the price of this preferred stock?

Answer 113

Correct Answer: $27.78 D = 5% of $50 = .05×$50 = $2.50 Vps = (D / kps) = 2.50 / 0.09 = 27.78

Question 114

(Preferred stockholder expected return) Spaceman Corp’s preferred stock is selling at $35.29 a share and pays a $2.26 dividend. What is the expected rate of return of Spaceman’s stock?

Answer 114

Correct Answer: 6.40% kps = D / Vcs = 2.26 / 35.29 = 6.40%

Question 115

(Preferred stockholder expected return) You own 252 shares of Global Services’ preferred stock, which currently sell for $18.12 and pay annual dividends of $1.19 per share. If you require a 10% return, given the current price, would you be interested in selling or buying more stock?

Answer 115

Correct Answer: You should sell the stock since it is overvalued by $6.22. Vps = D / kps = 1.19 / 0.10 = $11.90, so you should sell the stock since it is overvalued

Question 116

Some Co. is planning to pay a dividend of $5.60 in the next year and expects to grow the dividend at a constant rate of 4% per year, indefinitely. If the required rate of return by shareholders is 13%, then the price of this stock should be:

Answer 116

Correct Answer: $62.22 Price = 5.60/(0.13 – 0.04) = $62.22

Question 117

UHFD has just paid a dividend of $2.56 and is expected to increase the future dividends at a rate of 5% per year indefinitely. If you, as a share holder, require 15% per year, what is the current price per share?

Answer 117

Correct Answer: $26.88 Price = (2.56 X 1.05)/(0.15 - 0.05) = $26.88

Question 118

BlackHawk.com anticipates paying a dividend of $4.25 next year and is expected to grow the dividend at a constant rate of 7% per year, indefinitely. If the required rate of return by shares holders is 13%, then, according to the Gordon Model, what should the price of the stock be today?

Answer 118

Correct Answer: $70.83 V0 = $4.25 / (.13 - .07) = $4.25 / .06 = $70.83

Question 119

Liquid Systems Inc. has a unique dividend policy. This recent start up is expecting to pay a dividend of $2.00 in the next year, a dividend of $2.50 in year 2, and a dividend of $3.00 in the third year. After year 3, the company is anticipating increasing its dividend by 2.5% per year indefinitely. If the required return by shareholders is currently 12%, what is the price of the stock?

Answer 119

Correct Answer: $28.96 Year 1 2 3 4 Div 2 2.5 3 3.075* GGM 32.36842105** PV $1.79 $1.99 $2.14 $23.04 $28.95 *3 X (1 + .025) = 3.075 **V at 3 = 3.075/(0.12 – 0.025) = 32.3684

Question 120

Yukat Inc. is expecting to pay a dividend of $4.50 next year and then retain all of earnings thereafter. The expected price of the Yukat’s common stock is $45.60 next year. If the return required by share holders is 17%, what is the price of Yukat’s stock today?

Answer 120

Correct Answer: $42.82 P = (45.60 + 4.50)/1.17 = $42.82

Question 121

Another Co. just paid a dividend of $1.75. The company is expected to grow their dividend at a rate equal to their sustainable growth rate. The company recently reported a Return on Equity of 15% and paid out 25% of their net income in dividends. If the required rate of return by shareholders is 20% and the annual growth rate is 11.25%, what is the price of the stock today?

Answer 121

Correct Answer: $22.25 V0 = ($1.75 x 1.1125) / (0.20 - .1125) = $1.95 / .0875 = $22.25

Question 122

(Common shareholder expected return) Kiwi Pro’s common stock currently sells for $8.78 per share. The company executives anticipate a growth rate of 4% forever and a dividend of $1.05 next year. If you require a 15% rate of return, should you purchase the stock?

Answer 122

Correct Answer: You should buy because it is undervalued by $0.77. Vcs = D1 / (kcs – g) = 1.05/(0.15 – 0.04) = $9.55; The current price of the stock is only $8.78, which is less that the value of the stock, according to your analysis. Therefore, you should buy the stock (i.e. it is undervalued).