EXAM 5 PART 2

Your parents have an investment portfolio of $400,000, and they wish to take out cash flows of $50,000 per year as an ordinary annuity. How long will their portfolio last if the portfolio is invested at an annual rate of 4.50%? Use a calculator to determine your answer.

A. 8 years

B. 9.10 years

C. 9.60 years

D. 10.14 years

What is the present value of a lottery paid as an annuity due for 20 years if the cash flows are $250,000 per year and the appropriate discount rate is 7.50%?

A. $5,000,000.00

B. $3,186,045.39

C. $2,739,769.55

D. $2,548,622.84

Which is greater, the present value of a $1,000 five-year ordinary annuity discounted at 10%, or the present value of a $1,000 five-year annuity due discounted at 10%?

A. The ordinary annuity is worth more with a present value of $3,790.79.

B. The annuity due is worth more with a present value of $4,169.87.

C. The ordinary annuity is worth more with a present value of $4,169.87.

D. The annuity due is worth more with a present value of $4,586.85.

You just won the Publisher’s Clearing House Sweepstakes and the right to 20 after-tax ordinary annuity cash flows of $163,291.18. Assuming a discount rate of 7.50%, what is the present value of your lottery winnings? Use a calculator to determine your answer.

A. $3,265,823.60

B. $1,789,520.81

C. $1,664,670.52

D. There is not enough information to answer this question.

Your department at work places $10,000 every year-end into an account earning 5%. The money is used when the corporate office fails to fully finance your profitable projects. The money has not been touched since a deposit was made exactly five years ago. If the most recent deposit was made today, how much money is currently in the account?

A. $55,256.31

B. $60,000

C. $65,256.31

D. $68,019.13

Your employer has agreed to place year-end deposits of $1,000, $2,000, and $3,000 into your retirement account. The $1,000 deposit will be one year from today, the $2,000 deposit two years from today, and the $3,000 deposit three years from today. If your account earns 5% per year, how much money will you have in the account at the end of Year 3 when the last deposit is made?

A. $5,357.95

B. $6,000

C. $6,202.50

D. $6,727.88

If you borrow $50,000 at an annual interest rate of 12% for six years, what is the annual payment (prior to maturity) on an interest-only type of loan?

A. $0

B. $6,000

C. $8,333.33

D. $12,161.29

When interest rates are stated or given for loan repayments, it is assumed that they are __________ unless specifically stated otherwise.

A. daily rates

B. annual percentage rates

C. effective annual rates

D. APYs

A yield curve constructed using Treasury securities has each of the following components embedded in the nominal interest rates:

A. the real rate, expected inflation, and a default risk premium.

B. expected inflation, a default risk premium, and a maturity premium.

C. the real rate, expected inflation, and a maturity premium.

D. The real rate, a default risk premium, and expected inflation.

Nominal interest rates are the sum of two major components. These components are:

A. the real interest rate and expected inflation.

B. the risk-free rate and expected inflation.

C. the real interest rate and default premium.

D. the real interest rate and the T-bill rate.

We can write the true relationship between the nominal interest rate and the real rate and expected inflation as which of the following?

A. (1 + r) = (1 + r) × (1 + h*)

B. r = (1 + r*) × (1 + h) – 1

C. r* = (1 + r) × (1 + h) -1

D. r = (1 + r*) × (1 + h) + 1

Assume you just bought a new home and now have a mortgage on the home. The amount of the principal is $150,000, the loan is at 5% APR, and the monthly payments are spread out over 30 years. What is the loan payment? Use a calculator to determine your answer.

A. $798.95

B. $805.23

C. $850.32

D. $903.47

The number of periods for a consumer loan (n) is equal to the:

A. number of years times compounding periods per year.

B. number of years.

C. number of years in a period.

D. number of compounding periods.

As applied to mortgage loans, which of the following statements is FALSE?

A. Advertised rates are annual percentage rates.

B. A spreadsheet uses the periodic interest rate, not the annual percentage rate.

C. By increasing the number of payments per year you increase your effective borrowing rate.

D. A mortgage problem is unlike a future value problem with an annuity.

Which of the following statements is true?

A. By DECREASING the number of payments per year, you REDUCE your total cash outflow but INCREASE your effective borrowing rate.

B. By INCREASING the number of payments per year, you BOOST your total cash outflow but INCREASE your effective borrowing rate.

C. By INCREASING the number of payments per year, you REDUCE your total cash outflow but INCREASE your effective borrowing rate.

D. By INCREASING the number of payments per year, you REDUCE your total cash outflow but DECREASE your effective borrowing rate.

Assume that Don is 45 years old and has 20 years for saving until he retires. He expects an APR of 8.5% on his investments. How much does he need to save if he puts money away annually in equal end-of-the-year amounts to achieve a future value of $1 million in 20 years’ time?

A. $20,570.00

B. $20,670.97

C. $20,770.90

D. $20,800.00

The two major components of the interest rate that cause rates to vary across different investment opportunities or loans are:

A. the default premium and the bankruptcy premium.

B. the liquidity premium and the maturity premium.

C. the default premium and the maturity premium.

D. the inflation premium and the maturity premium.

You put down 20% on a home with a purchase price of $300,000. The down payment is thus $60,000, leaving a balance owed of $240,000. The bank will loan you the remaining balance at 4.28% APR. You will make annual payments with a 20-year payment schedule. What is the annual annuity payment under this schedule?

A. $18,100.23

B. $22,625.29

C. $12,000.00

D. $33,785.23

If you take out a loan from a bank, you will be charged:

A. for principal but not interest.

B. for interest but not principal.

C. for both principal and interest.

D. for interest only.

Suppose you postpone consumption so that by investing at 8% you will have an extra $800 to spend in one year. Suppose that inflation is 4% during this time. What is the approximate real increase in your purchasing power?

A. $800

B. $600

C. $400

D. $200

The Fisher Effect involves which of the items below?

A. Nominal rate, the real rate, and inflation

B. Nominal rate and the real rate only

C. Nominal rate and inflation only

D. Nominal rate, the bond rate, and inflation

Which of the following statements is true?

A. On many calculators the TVM key for interest is I/Y; this is Interest per Year, or the EAR rate.

B. On many calculators the TVM key for interest is Y/I; this is Interest per Year, or the APR rate.

C. On many calculators the TVM key for interest is I/Y; this is Interest per Year, or the APR rate.

D. On many calculators the TVM key for a period is I/Y.

Suppose you deposit money in a certificate of deposit (CD) at a bank. Which of the following statements is true?

A. The bank is borrowing money from you without a promise to repay that money with interest.

B. The bank is lending money to you with a promise to repay that money with interest.

C. The bank is technically renting money from you with a promise to repay that money with interest.

D. The bank is lending money to you, but not borrowing money from you.

Suppose you invest $1,000 today, compounded quarterly, with the annual interest rate of 5%. What is your investment worth in one year?

A. $1,025.00

B. $1,500.95

C. $1,025.27

D. $1,050.95

Suppose that over the life of the loan, the total interest expense for a

monthly loan is $17,000, while the total interest payment for an annual

loan is $19,000. Which of the below statements is FALSE?

A. The difference reflects the reduction of the principal each month versus

the annual reduction of the principal.

B. The more frequent the payment, the lower the total interest expense over

the life of the loan, even though the effective rate of the loan is higher.

C. Reducing principal at a slower pace reduces the overall interest paid on

a loan.

D. Reducing principal at a slower pace increases the overall interest paid

on a loan.

Suppose you invest $2,000 today, compounded monthly, with an annual interest rate of 7.5%. What is your investment worth in one year?

A. $2,150

B. $2,152.81

C. $2,155.27

D. $2,154.77

The phrase “price to rent money” is sometimes used to refer to:

A. historical prices.

B. compound rates.

C. discount rates.

D. interest rates.

EXAM 8

Jarvis bought a share of stock for $15.75 that paid a dividend of $.45 and sold three months later for $18.65. What was his dollar profit or loss and holding period return?

A. $2.90, 18.41%

B. $3.35, 21.27%

C. -$2.90, -18.41%

D. $.45, 2.86%

The practice of not putting all of your eggs in one basket is an illustration of:

A. variance.

B. diversification.

C. portion control.

D. expected return.

The __________ is the intercept on the security market line.

A. prime rate

B. risk-free rate

C. market rate of return

D. beta

Which of the following investments is considered to be default risk-free?

A. Currency options

B. AAA-rated corporate bonds

C. Common stock

D. Treasury bills

For purposes of maximum portfolio diversification, which of the following would provide the greatest diversification?

A. Security A with a correlation coefficient of -0.0

B. Security B with a correlation coefficient of 0.0

C. Security C with a correlation coefficient of -0.50

D. Security D with a correlation coefficient of 0.50

States of the Economy

Probability of the State

3-Month T-Bill

Large-Company Stock

Small-Company Stock

Boom

0.3

4

10

30

Steady

0.5

4

5

20

Recession

0.2

4

0

10

What is the difference between the variances for large- and small-company stocks?

A. 40.25%

B. 36.75%

C. 27.30%

D. 14.90%

Which of the statements below is true?

A. Investors want to maximize return and maximize risk.

B. Investors want to maximize return and minimize risk.

C. Investors want to minimize return and maximize risk.

D. Investors want to minimize return and minimize risk.

Correlation, a standardized measure of how stocks perform relative to one another in different states of the economy, has a range from:

A. 0.0 to +10.0.

B. 0.0 to +1.0.

C. -1.0 to +1.0.

D. There is no range; correlation is a calculated number that can take on any value.

The type of risk that can be diversified away is called:

A. unsystematic risk.

B. systematic risk.

C. nondiversifiable risk.

D. system-wide risk.

__________ may be defined as a measure of uncertainty in a set of potential outcomes for an event in which there is a chance for some loss.

A. Diversification

B. Risk

C. Uncertainty

D. Collaboration

Which of the following statements is true about variance?

A. Variance describes how spread out a set of numbers or values are around its mean or average.

B. Variance is essentially the variability from the average.

C. The larger the variance, the greater the dispersion.

D. All of the above statements are true.

__________ is risk that cannot be diversified away.

A. Unsystematic risk

B. Systematic risk

C. Firm-specific risk

D. Diversifiable risk

Unsystematic risk:

A. is also known as nondiversifiable risk.

B. can be diversified away.

C. is system-wide risk.

D. is equal to 2 times the systematic risk.

The correlation coefficient, a measurement of the comovement between two variables, has what range?

A. From 0.0 to +10.0

B. From 0.0 to +1.0

C. From -1.0 to +10.0

D. From +1.0 to -1.0

Stocks A, B, C, and D have returns of 10%, 20%, 30%, and 40%, respectively. What is their variance?

A. 66.67%

B. 166.67%

C. 4.08%

D. 2.15%

Joe bought a share of stock for $47.50 that paid a dividend of $.72 and sold one year later for $51.38. What was Joe’s dollar profit or loss and holding period return?

A. $0.72, 7.55%

B. $3.88, 8.95%

C. $4.60, 9.68%

D. $3.88, 9.68%

Find the variance for a security that has three one-year returns of 5%, 10%, and 15%.

A. 10%

B. 16.67%

C. 25%

D. 30%

The terms __________ and __________ mean the same thing.

A. nondiversifiable risk; unsystematic risk

B. diversifiable risk; systematic risk

C. diversifiable risk; unsystematic risk

D. total risk; unique risk

Stocks A, B, C, and D have standard deviations, respectively, of 20%, 5%, 10%, and 15%. Which one is the riskiest?

A. Stock A

B. Stock B

C. Stock C

D. Stock D

Stock

A

B

C

D

Expected Return

5%

5%

7%

6%

Standard Deviation

10%

12%

12%

11%

Which of the following statements is true?

A. A is a better investment than B.

B. B is a better investment than C.

C. C is a better investment than D.

D. D is a better investment than C.

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