TMV Flashcards
(44 cards)
- In 10 years, what is the value of $100 invested today at an interest rate of 8% per year, compounded monthly?
A) $222.
B)$216.
C)$180.
N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = –1,000; CPT → FV = 1,573.52.
- If $1,000 is invested at the beginning of the year at an annual rate of 48%, compounded quarterly, what would that investment be worth at the end of the year?
A) $1,574.
B)$1,048.
C)$4,798.
N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = –1,000; CPT → FV = 1,573.52.
- Jamie Morgan needs to accumulate $2,000 in 18 months. If she can earn 6% at the bank, compounded quarterly, how much must she deposit today?
A) $1,829.08.
B) $1,832.61.
C) $1,840.45.
Each quarter of a year is comprised of 3 months thus N = 18 / 3 = 6; I/Y = 6 / 4 = 1.5; PMT = 0; FV = 2,000; CPT → PV = $1,829.08.
- Vega research has been conducting investor polls for Third State Bank. They have found the most investors are not willing to tie up their money in a 1-year (2-year) CD unless they receive at least 1.0% (1.5%) more than they would on an ordinary savings account. If the savings account rate is 3%, and the bank wants to raise funds with 2-year CDs, the yield must be at least:
A) 4.0%, and this represents a required rate of return.
B) 4.5%, and this represents a required rate of return.
C) 4.5%, and this represents a discount rate.
BSince we are taking the view of the minimum amount required to induce investors to lend funds to the bank, this is best described as a required rate of return. Based upon the numerical information, the rate must be 4.5% (= 3.0 + 1.5).
- Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside and held for the trip, he should use the 5% as a:
A) required rate of return. B) discount rate.
C) opportunity cost.
B - He needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate.
- Which one of the following statements best describes the components of the required interest rate on a security?
A) The nominal risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security
B) The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security
C) The real risk-free rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security.
B
The required interest rate on a security is made up of the nominal rate which is in turn made up of the real risk-free rate plus the expected inflation rate. It should also contain a liquidity premium as well as a premium related to the maturity of the security.
- T-bill yields can be thought of as:
A) nominal risk-free rates because they do not contain an inflation premium
B) real risk-free rates because they contain an inflation premium. C)nominal risk-free rates because they contain an inflation premium.
C
T-bills are government issued securities and are therefore considered to be default risk free. More precisely, they are nominal risk-free rates rather than real risk-free rates since they contain a premium for expected inflation.
- A local bank offers an account that pays 8%, compounded quarterly, for any deposits of $10,000 or more that are left in the account for a period of 5 years. The effective annual rate of interest on this account is:
A) 4.65%.
B) 9.01%.
C) 8.24%.
C
(1 + periodic rate)m − 1 = (1.02)4 − 1 = 8.24%.
- Which of the following is the most accurate statement about stated and effective annual interest rates?
A)The stated annual interest rate is used to find the effective annual r ate. B)The stated rate adjusts for the frequency of compounding.
C)So long as interest is compounded more than once a year, the stated annual rate will always be more than the effective rate.
A
The effective annual rate, not the stated rate, adjusts for the frequency of compounding. The nominal, stated, and stated annual rates are all the same thing.
- In 10 years, what is the value of $100 invested today at an interest rate of 8% per year, compounded monthly?
A) $222. B) $216. C) $180.
A
N = 10 × 12 = 120; I/Y = 8/12 = 0.666667; PV = –100; PMT = 0; CPT → FV = 221.96.
- If $1,000 is invested at the beginning of the year at an annual rate of 48%, compounded quarterly, what would that investment be worth at the end of the year?
A)$1,048. B)$1,574. C)$4,798.
B
N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = –1,000; CPT → FV = 1,573.52.
- An investor deposits $10,000 in a bank account paying 5% interest compounded annually. Rounded to the nearest dollar, in 5 years the investor will have:
A)$12,500. B)$10,210. C)$12,763.
C
PV = 10,000; I/Y = 5; N = 5; CPT → FV = 12,763.
or: 10,000(1.05)5 = 12,763.
- If a person needs $20,000 in 5 years from now and interest rates are currently 6% how much do they need to invest today if interest is compounded annually?
A)$14,945. B)$14,683. C)$15,301.
A
PV = FV / (1 + r)n = 20,000 / (1.06)5 = 20,000 / 1.33823 = $14,945
N = 5; I/Y = 6%; PMT = 0; FV = $20,000; CPT → PV = -$14,945.16
- Natalie Brunswick, neurosurgeon at a large U.S. university, was recently granted permission to take an 18-month sabbatical that will begin one year from today. During the sabbatical, Brunswick will need $2,500 at the beginning of each month for living expenses that month. Her financial planner estimates that she will earn an annual rate of 9% over the next year on any money she saves. The annual rate of return during her sabbatical term will likely increase to 10%. At the end of each month during the year before the sabbatical, Brunswick should save approximately:
A)$3,505. B)$3,356. C)$3,330.
B
This is a two-step problem. First, we need to calculate the present value of the amount she needs over her sabbatical. (This amount will be in the form of an annuity due since she requires the payment at the beginning of the month.) Then, we will use future value formulas to determine how much she needs to save each month (ordinary annuity).
Step 1:Calculate present value of amount required during the sabbatical
Using a financial calculator: Set to BEGIN Mode, then N = 12 × 1.5 = 18; I/Y = 10 / 12 = 0.8333; PMT = 2,500; FV = 0; CPT → PV = 41,974
Step 2:Calculate amount to save each month
Make sure the calculator is set to END mode, then N = 12; I/Y = 9 / 12 = 0.75; PV = 0; FV = 41,974; CPT → PMT = -3,356
- John is getting a $25,000 loan, with an 8% annual interest rate to be paid in 48 equal monthly installments. If the first payment is due at the end of the first month, the principal and interest values for the first payment are closest to:
Principal Interest
A) $410.32 $200.00 B) $443.65 $200.00 C) $443.65 $166.67
C
Calculate the payment first:
N = 48; I/Y = 8/12 = 0.667; PV = 25,000; FV = 0; CPT PMT = 610.32.
Interest = 0.006667 × 25,000 = $166.67; Principal = 610.32 – 166.67 = $443.65 .
- The capital budgeting director of Green Manufacturing is evaluating a laser imaging project with the following characteristics:
Cost: $150,000
Expected life: 3 years
After-tax cash flows: $60,317 per year
Salvage value: $0
If Green Manufacturing’s cost of capital is 11.5%, what is the project’s internal rate of return (IRR)?
A) 10.0%. B) 13.6%. C) $3,875.
A
Since we are seeking the IRR, the answer has to be in terms of a rate of return, this eliminates the option not written in a percentage.
Since they payments (cash flows) are equals, we can calculate the IRR as: N = 3; PV = 150,000; PMT = 60,317; CPT → I/Y = 9.999
- In order to calculate the net present value (NPV) of a project, an analyst would least likely need to know the:
A) timing of the expected cash flows from the project. B) opportunity cost of capital for the project. C) internal rate of return (IRR) of the project.
C
The NPV is calculated using the opportunity cost, discount rate, expected cash flows, and timing of the expected cash flows from the project. The project’s IRR is not used to calculate the NPV.
- An investment with a cost of $5,000 is expected to have cash inflows of $3,000 in year 1, and $4,000 in year 2. The internal rate of return (IRR) for this investment is closest to:
A) 25%. B) 15%. C) 30%.
A
The IRR is the discount rate that makes the net present value of the investment equal to 0.
This means -$5,000 + $3,000 / (1 + IRR) + $4,000 / (1 + IRR)2 = 0
One way to compute this problem is to use trial and error with the existing answer choices and choose the discount rate that makes the PV of the cash flows closest to 5,000.
$3,000 / (1.25) + $4,000 / (1.25)2 = 4,960.
Alternatively: CFO = -5,000; CF1 = 3,000; CF2 = 4,000; CPT → IRR = 24.3%.
- Jack Smith, CFA, is analyzing independent investment projects X and Y. Smith has calculated the net present value (NPV) and internal rate of return (IRR) for each project:
Project X: NPV = $250; IRR = 15%
Project Y: NPV = $5,000; IRR = 8%
Smith should make which of the following recommendations concerning the two projects?
A) Accept Project X only. B) Accept both projects. C) Accept Project Y only.
B
The projects are independent, meaning that either one or both projects may be chosen. Both projects have positive NPVs, therefore both projects add to shareholder wealth and both projects should be accepted.
- Which of the following statements regarding making investment decisions using net present value (NPV) and internal rate of return (IRR) is least accurate?
A) Projects with a positive NPVs increase shareholder wealth. B) If a firm undertakes a zero-NPV project, the firm will get larger, but shareholder wealth will not change. C) If two projects are mutually exclusive, one should always choose the project with the highest IRR.
C
If two projects are mutually exclusive, the firm should always choose the project with the highest NPV rather than the highest IRR. If two projects are mutually exclusive, the firm may only choose one. It is possible for NPV and IRR to give conflicting decisions for projects of different sizes. Because NPV is a direct measure of the change in shareholder wealth, NPV criteria should be used when NPV and IRR decisions conflict.
When a project has a positive NPV, it will add to shareholder wealth because the project is earning more than the opportunity cost of capital needed to undertake the project. If a firm takes on a zero-NPV project, the firm will earn exactly enough to cover the opportunity cost of capital. The firm will increase in size by taking the project, but shareholder wealth will not change.
- An investor expects a stock currently selling for $20 per share to increase to $25 by year-end. The dividend last year was $1 but he expects this year’s dividend to be $1.25. What is the expected holding period return on this stock?
A) 31.25%. B) 24.00%. C) 28.50%.
A
Return = [dividend + (end − begin)] / beginning price
R = [1.25 + (25 − 20)] / 20 = 6.25 / 20 = 0.3125
- An investor is considering investing in Tawari Company for one year. He expects to receive $2 in dividends over the year and feels he can sell the stock for $30 at the end of the year. To realize a return on the investment over the year of 14%, the price the investor would pay for the stock today is closest to:
A) $29. B) $32. C) $28.
C
HPR = [Dividend + (Ending price − Beginning price)] / Beginning price
0.14 = [2 + (30 − P)] / P
1.14P = 32 so P = $28.07
- On January 1, Jonathan Wood invests $50,000. At the end of March, his investment is worth $51,000. On April 1, Wood deposits $10,000 into his account, and by the end of June, his account is worth $60,000. Wood withdraws $30,000 on July 1 and makes no additional deposits or withdrawals the rest of the year. By the end of the year, his account is worth $33,000. The time-weighted return for the year is closest to:
A) 7.0%. B) 5.5%. C) 10.4%.
C
January – March return = 51,000 / 50,000 − 1 = 2.00%April – June return = 60,000 / (51,000 + 10,000) − 1 = –1.64%July – December return = 33,000 / (60,000 − 30,000) − 1 = 10.00%Time-weighted return = [(1 + 0.02)(1 − 0.0164)(1 + 0.10)] − 1 = 0.1036 or 10.36%
- Which of the following is most accurate with respect to the relationship of the money-weighted return to the time-weighted return? If funds are contributed to a portfolio just prior to a period of favorable performance, the:
A) time-weighted rate of return will tend to be elevated. B) money-weighted rate of return will tend to be elevated. C) money-weighted rate of return will tend to be depressed.
B
The time-weighted returns are what they are and will not be affected by cash inflows or outflows. The money-weighted return is susceptible to distortions resulting from cash inflows and outflows. The money-weighted return will be biased upward if the funds are invested just prior to a period of favorable performance and will be biased downward if funds are invested just prior to a period of relatively unfavorable performance. The opposite will be true for cash outflows.
