Exercise 1 for Time Value of Money ANS: C

MULTIPLE CHOICE 4. Which of the following statements is

CORRECT?
1. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows
occur annually.
a. A time line is not meaningful unless all cash flows b. Time lines are not useful for visualizing complex
occur annually. problems prior to doing actual calculations.
b. Time lines are useful for visualizing complex c. Time lines cannot be constructed to deal with
problems prior to doing actual calculations. situations where some of the cash flows occur
c. Time lines cannot be constructed in situations annually but others occur quarterly.
where some of the cash flows occur annually but d. Time lines can only be constructed for annuities
others occur quarterly. where the payments occur at the end of the periods,
d. Time lines cannot be constructed for annuities i.e., for ordinary annuities.
where the payments occur at the beginning of the e. Time lines can be constructed where some of the
periods. payments constitute an annuity but others are
e. Some of the cash flows shown on a time line can be unequal and thus are not part of the annuity.
in the form of annuity payments, but none can be ANS: E
uneven amounts.
5. You plan to analyze the value of a potential
ANS: B investment by calculating the sum of the present
values of its expected cash flows. Which of the
2. Which of the following statements is CORRECT? following would lower the calculated value of the
investment?
a. A time line is not meaningful unless all cash flows a. The cash flows are in the form of a deferred
occur annually. annuity, and they total to $100,000. You learn that
b. Time lines are not useful for visualizing complex the annuity lasts for only 5 rather than 10 years,
problems prior to doing actual calculations. hence that each payment is for $20,000 rather than
c. Time lines cannot be constructed in situations for $10,000.
where some of the cash flows occur annually but b. The discount rate increases.
others occur quarterly. c. The riskiness of the investment's cash flows
d. Time lines can be constructed for annuities where decreases.
the payments occur at either the beginning or the end d. The total amount of cash flows remains the same,
of the periods. but more of the cash flows are received in the earlier
e. Some of the cash flows shown on a time line can be years and less is received in the later years.
in the form of annuity payments, but none can be e. The discount rate decreases.
uneven amounts.
ANS: B
ANS: D
6. You plan to analyze the value of a potential
3. Which of the following statements is CORRECT? investment by calculating the sum of the present
a. A time line is not meaningful unless all cash flows values of its expected cash flows. Which of the
occur annually. following would increase the calculated value of the
b. Time lines are not useful for visualizing complex investment?
problems prior to doing actual calculations. a. The cash flows are in the form of a deferred
c. Time lines can be constructed to deal with annuity, and they total to $100,000. You learn that
situations where some of the cash flows occur the annuity lasts for 10 years rather than 5 years,
annually but others occur quarterly. hence that each payment is for $10,000 rather than
d. Time lines can only be constructed for annuities for $20,000.
where the payments occur at the end of the periods, b. The discount rate decreases.
i.e., for ordinary annuities. c. The riskiness of the investment's cash flows
e. Time lines cannot be constructed where some of increases.
the payments constitute an annuity but others are d. The total amount of cash flows remains the same,
unequal and thus are not part of the annuity. but more of the cash flows are received in the later
years and less are received in the earlier years.
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e. The discount rate increases. a. The periodic rate of interest is 2% and the effective
ANS: B rate of interest is 4%.
b. The periodic rate of interest is 8% and the effective
7. Which of the following statements is CORRECT? rate of interest is greater than 8%.
a. The cash flows for an ordinary (or deferred) annuity c. The periodic rate of interest is 4% and the effective
all occur at the beginning of the periods. rate of interest is less than 8%.
b. If a series of unequal cash flows occurs at regular d. The periodic rate of interest is 2% and the effective
intervals, such as once a year, then the series is by rate of interest is greater than 8%.
definition an annuity. e. The periodic rate of interest is 8% and the effective
c. The cash flows for an annuity due must all occur at rate of interest is also 8%.
the ends of the periods. ANS: D
d. The cash flows for an annuity must all be equal, and
they must occur at regular intervals such as once a 11. A $50,000 loan is to be amortized over 7 years,
year or once a month. with annual end-of-year payments. Which of these
e. If some cash flows occur at the beginning of the statements is CORRECT?
periods while others occur at the ends, then we have a. The annual payments would be larger if the interest
what the textbook defines as a variable annuity. rate were lower.
b. If the loan were amortized over 10 years rather
ANS: D than 7 years, and if the interest rate were the same in
either case, the first payment would include more
8. Which of the following statements is CORRECT? dollars of interest under the
a. The cash flows for an ordinary (or deferred) annuity 7-year amortization plan.
all occur at the beginning of the periods. c. The proportion of each payment that represents
b. If a series of unequal cash flows occurs at regular interest as opposed to repayment of principal would
intervals, such as once a year, then the series is by be lower if the interest rate were lower.
definition an annuity. d. The last payment would have a higher proportion
c. The cash flows for an annuity due must all occur at of interest than the first payment.
the beginning of the periods. e. The proportion of interest versus principal
d. The cash flows for an annuity may vary from period repayment would be the same for each of the 7
to period, but they must occur at regular intervals, payments.
such as once a year or once a month. ANS: C
e. If some cash flows occur at the beginning of the
periods while others occur at the ends, then we have 12. A $150,000 loan is to be amortized over 7 years,
what the textbook defines as a variable annuity. with annual end-of-year payments. Which of these
ANS: C statements is CORRECT?
a. The annual payments would be larger if the interest
9. Your bank account pays a 6% nominal rate of rate were lower.
interest. The interest is compounded quarterly. Which b. If the loan were amortized over 10 years rather
of the following statements is CORRECT? than 7 years, and if the interest rate were the same in
a. The periodic rate of interest is 1.5% and the either case, the first payment would include more
effective rate of interest is 3%. dollars of interest under the
b. The periodic rate of interest is 6% and the effective 7-year amortization plan.
rate of interest is greater than 6%. c. The proportion of each payment that represents
c. The periodic rate of interest is 1.5% and the interest as opposed to repayment of
effective rate of interest is greater than 6%. principal would be higher if the interest rate were
d. The periodic rate of interest is 3% and the effective lower.
rate of interest is 6%. d. The proportion of each payment that represents
e. The periodic rate of interest is 6% and the effective interest versus repayment of principal would be
rate of interest is also 6%. higher if the interest rate were higher.
ANS: C e. The proportion of interest versus principal
repayment would be the same for each of the 7
10. Your bank account pays an 8% nominal rate of payments.
interest. The interest is compounded quarterly. Which ANS: D
of the following statements is CORRECT?

2
13. Which of the following statements regarding a 15- 16. Which of the following statements regarding a 30-
year (180-month) $125,000, fixed-rate mortgage is year monthly payment amortized mortgage with a
CORRECT? (Ignore taxes and transactions costs.) nominal interest rate of 10% is CORRECT?
a. The remaining balance after three years will be a. The monthly payments will increase over time.
$125,000 less one third of the interest paid during the b. A larger proportion of the first monthly payment
first three years. will be interest, and a smaller proportion
b. Because it is a fixed-rate mortgage, the monthly will be principal, than for the last monthly payment.
loan payments (which include both interest and c. The total dollar amount of interest being paid off
principal payments) are constant. each month gets larger as the loan approaches
c. Interest payments on the mortgage will increase maturity.
steadily over time, but the total amount of each d. The amount representing interest in the first
payment will remain constant. payment would be higher if the nominal
d. The proportion of the monthly payment that goes interest rate were 7% rather than 10%.
towards repayment of principal will be lower 10 years e. Exactly 10% of the first monthly payment
from now than it will be the first year. represents interest.
e. The outstanding balance declines at a slower rate in ANS: B
the later years of the loan
ANS: B 17. Which of the following investments would have
the highest future value at the end of 10 years?
14. Which of the following statements regarding a 15- Assume that the effective annual rate for all
year (180-month) $125,000, fixed-rate mortgage is investments is the same and is greater than zero.
CORRECT? (Ignore taxes and transactions costs.) a. Investment A pays $250 at the beginning of every
a. The remaining balance after three years will be year for the next 10 years (a total of 10
$125,000 less one third of the interest paid during the payments).
first three years. b. Investment B pays $125 at the end of every 6-
b. Because the outstanding balance declines over month period for the next 10 years (a total of 20
time, the monthly payments will also decline over payments).
time. c. Investment C pays $125 at the beginning of every 6-
c. Interest payments on the mortgage will increase month period for the next 10 years (a total of 20
steadily over time, but the total amount of each payments).
payment will remain constant. d. Investment D pays $2,500 at the end of 10 years
d. The proportion of the monthly payment that goes (just one payment).
towards repayment of principal will be lower 10 years e. Investment E pays $250 at the end of every year for
from now than it will be the first year. the next 10 years (a total of 10 payments).
e. The outstanding balance declines at a faster rate in ANS: A
the later years of the loan
ANS: E 18. Which of the following investments would have
the lowest present value? Assume that the effective
15. Which of the following statements regarding a 30- annual rate for all investments is the same and is
year monthly payment amortized mortgage with a greater than zero.
nominal interest rate of 10% is CORRECT? a. Investment A pays $250 at the end of every year for
a. The monthly payments will decline over time. the next 10 years (a total of 10 payments).
b. A smaller proportion of the last monthly payment b. Investment B pays $125 at the end of every 6-
will be interest, and a larger proportion will be month period for the next 10 years (a total of 20
principal, than for the first monthly payment. payments).
c. The total dollar amount of principal being paid off c. Investment C pays $125 at the beginning of every 6-
each month gets smaller as the loan approaches month period for the next 10 years (a total of 20
maturity. payments).
d. The amount representing interest in the first d. Investment D pays $2,500 at the end of 10 years
payment would be higher if the nominal interest rate (just one payment).
were 7% rather than 10%. e. Investment E pays $250 at the beginning of every
e. Exactly 10% of the first monthly payment year for the next 10 years (a total of 10 payments).
represents interest. ANS: D
ANS: B

3
19. A U.S. Treasury bond will pay a lump sum of a. The present value of a 5-year, $250 annuity due will
$1,000 exactly 3 years from today. The nominal be lower than the PV of a similar ordinary annuity.
interest rate is 6%, semiannual compounding. Which b. A 30-year, $150,000 amortized mortgage will have
of the following statements is CORRECT? larger monthly payments than an otherwise similar
a. The periodic interest rate is greater than 3%. 20-year mortgage.
b. The periodic rate is less than 3%. c. A bank loan's nominal interest rate will always be
c. The present value would be greater if the lump sum equal to or greater than its effective annual rate.
were discounted back for more periods. d. If an investment pays 10% interest, compounded
d. The present value of the $1,000 would be smaller if quarterly, its effective annual rate will be greater than
interest were compounded monthly rather than 10%.
semiannually. e. Banks A and B offer the same nominal annual rate
e. The PV of the $1,000 lump sum has a higher of interest, but A pays interest quarterly and B pays
present value than the PV of a 3-year, $333.33 semiannually. Deposits in Bank B will provide the
ordinary annuity. higher future value if you leave your funds on deposit.
ANS: D ANS: D

20. A U.S. Treasury bond will pay a lump sum of 23. Which of the following statements is CORRECT?
$1,000 exactly 3 years from today. The nominal a. The present value of a 3-year, $150 annuity due will
interest rate is 6%, semiannual compounding. Which exceed the present value of a 3-year, $150 ordinary
of the following statements is CORRECT? annuity.
a. The periodic interest rate is greater than 3%. b. If a loan has a nominal annual rate of 8%, then the
b. The periodic rate is less than 3%. effective rate can never be greater than
c. The present value would be greater if the lump sum 8%.
were discounted back for more periods. c. If a loan or investment has annual payments, then
d. The present value of the $1,000 would be larger if the effective, periodic, and nominal rates of interest
interest were compounded monthly rather than will all be different.
semiannually. d. The proportion of the payment that goes toward
e. The PV of the $1,000 lump sum has a smaller interest on a fully amortized loan increases over time.
present value than the PV of a 3-year, $333.33 e. An investment that has a nominal rate of 6% with
ordinary annuity. semiannual payments will have an effective rate that
ANS: E is smaller than 6%.
ANS: A
21. Which of the following statements is CORRECT,
assuming positive interest rates and holding other 24. Which of the following statements is CORRECT?
things constant? a. The present value of a 3-year, $150 ordinary
a. The present value of a 5-year, $250 annuity due will annuity will exceed the present value of a 3- year,
be lower than the PV of a similar ordinary annuity. $150 annuity due.
b. A 30-year, $150,000 amortized mortgage will have b. If a loan has a nominal annual rate of 8%, then the
larger monthly payments than an otherwise similar effective rate will never be less than
20-year mortgage. 8%.
c. A bank loan's nominal interest rate will always be c. If a loan or investment has annual payments, then
equal to or less than its effective annual rate. the effective, periodic, and nominal rates of interest
d. If an investment pays 10% interest, compounded will all be different.
annually, its effective annual rate will be less than d. The proportion of the payment that goes toward
10%. interest on a fully amortized loan increases over time.
e. Banks A and B offer the same nominal annual rate e. An investment that has a nominal rate of 6% with
of interest, but A pays interest quarterly and B pays semiannual payments will have an effective rate that
semiannually. Deposits in Bank B will provide the is smaller than 6%.
higher future value if you leave your funds on deposit. ANS: B
ANS: C
25. You are considering two equally risky annuities,
22. Which of the following statements is CORRECT, each of which pays $5,000 per year for 10 years.
assuming positive interest rates and holding other Investment ORD is an ordinary (or deferred) annuity,
things constant? while Investment DUE is an annuity due. Which of the
following statements is CORRECT?
4
a. The present value of ORD must exceed the present d. If you solve for I and get a negative number,
value of DUE, but the future value of then you must have made a mistake.
ORD may be less than the future value of DUE. e. If CF0 is positive and all the other CFs are
b. The present value of DUE exceeds the present value negative, then you cannot solve for I.
of ORD, while the future value of DUE is less than the ANS: C
future value of ORD.
c. The present value of ORD exceeds the present value 28. Which of the following statements is
of DUE, and the future value of CORRECT?
ORD also exceeds the future value of DUE. a. If you have a series of cash flows, each of which is
d. The present value of DUE exceeds the present value positive, you can solve for I, where the solution value
of ORD, and the future value of of I causes the PV of the cash flows to equal the cash
DUE also exceeds the future value of ORD. flow at Time 0.
e. If the going rate of interest decreases from 10% to b. If you have a series of cash flows, and CF0 is
0%, the difference between the present value of ORD negative but each of the following CFs is positive, you
and the present value of DUE would remain constant. can solve for I, but only if the sum of the
ANS: D undiscounted cash flows exceeds the cost.
c. To solve for I, one must identify the value of I that
26. You are considering two equally risky annuities, causes the PV of the positive CFs to equal the absolute
each of which pays $5,000 per year for 10 years. value of the FV of the negative CFs. It is impossible to
Investment ORD is an ordinary (or deferred) annuity, find the value of I without a computer or financial
while Investment DUE is an annuity due. Which of the calculator.
following statements is CORRECT? d. If you solve for I and get a negative number, then
a. A rational investor would be willing to pay more for you must have made a mistake.
DUE than for ORD, so their market prices should e. If CF0 is positive and all the other CFs are negative,
differ. then you can still solve for I.
b. The present value of DUE exceeds the present value ANS: E
of ORD, while the future value of DUE is less than the
future value of ORD. 29. Which of the following bank accounts has the
c. The present value of ORD exceeds the present value highest effective annual return?
of DUE, and the future value of a. An account that pays 8% nominal interest with
ORD also exceeds the future value of DUE. monthly compounding.
d. The present value of ORD exceeds the present b. An account that pays 8% nominal interest with
value of DUE, while the future value of annual compounding.
DUE exceeds the future value of ORD. c. An account that pays 7% nominal interest with daily
e. If the going rate of interest decreases from 10% to (365-day) compounding.
0%, the difference between the present value of ORD d. An account that pays 7% nominal interest with
and the present value of DUE would remain constant. monthly compounding.
ANS: A e. An account that pays 8% nominal interest with daily
(365-day) compounding.
27. Which of the following statements is CORRECT? ANS: E
a. If you have a series of cash flows, each of which is
positive, you can solve for I, where the solution value 30. Which of the following bank accounts has the
of I causes the PV of the cash flows to equal the cash lowest effective annual return?
flow at Time 0. a. An account that pays 8% nominal interest with
b. If you have a series of cash flows, and CF0 is monthly compounding.
negative but each of the following CFs is positive, you b. An account that pays 8% nominal interest with
can solve for I, but only if the sum of the annual compounding.
undiscounted cash flows exceeds the cost. c. An account that pays 7% nominal interest with daily
c. To solve for I, one must identify the value of I (365-day) compounding.
that causes the PV of the positive CFs to equal the d. An account that pays 7% nominal interest with
absolute value of the PV of the negative CFs. This is, monthly compounding.
essentially, a trial-and- error procedure that is easy e. An account that pays 8% nominal interest with daily
with a computer or financial calculator but quite (365-day) compounding.
difficult ANS: D
otherwise.
5
31. You plan to invest some money in a bank account. 36. Last year Rocco Corporation's sales were $725
Which of the following banks provides you with the million. If sales grow at 6% per year, how large (in
highest effective rate of interest? millions) will they be 5 years later?
a. Bank 1; 6.1% with annual compounding. a. $756.77
b. Bank 2; 6.0% with monthly compounding. b. $1,096.34
c. Bank 3; 6.0% with annual compounding. c. $1,212.77
d. Bank 4; 6.0% with quarterly compounding. d. $921.70
e. Bank 5; 6.0% with daily (365-day) compounding. e. $970.21
ANS: E ANS: E

32.Sue now has $490. How much would she have 37. Last year Dania Corporation's sales were $525
after 8 years if she leaves it invested at 8.5% with million. If sales grow at 7.0% per year, how large (in
annual compounding? millions) will they be 8 years later?
a. $941.10 a. $1,028.33
b. $724.64 b. $757.72
c. $837.58 c. $793.80
d. $1,148.14 d. $1,109.52
e. $1,157.55 e. $902.05
ANS: A ANS: E

33. Jose now has $500. How much would he have 38. How much would $1, growing at 8.5% per year, be
after 6 years if he leaves it invested at 7.5% with worth after 75 years?
annual compounding? a. $426.93
a. $679.05 b. $563.19
b. $763.93 c. $454.18
c. $910.55 d. $413.31
d. $879.68 e. $449.64
e. $771.65 ANS: C
ANS: E 39. How much would $100, growing at 5% per year,
be worth after 20 years?
a. $254.72
34. Suppose you have $1,425 and plan to purchase a b. $286.56
5-year certificate of deposit (CD) that pays 3.5% c. $265.33
interest, compounded annually. How much will you d. $281.25
have when the CD matures? e. $331.66
a. $1,810.92 ANS: C
b. $1,692.45
c. $1,827.85 40. You deposit $825 today in a savings account that
d. $2,047.87 pays 3.5% interest, compounded annually. How much
e. $1,709.38 will your account be worth at the end of 25 years?
ANS: B a. $1,949.68
b. $2,242.13
c. $1,969.17
35. Suppose you have $2,000 and plan to purchase a d. $1,637.73
10-year certificate of deposit (CD) that pays 4.0% e. $2,008.17
interest, compounded annually. How much will you ANS: A
have when the CD matures?
a. $2,516.42 41. You deposit $500 today in a savings account that
b. $2,960.49 pays 3.5% interest, compounded annually. How much
c. $3,641.40 will your account be worth at the end of 10 years?
d. $3,019.70 a. $867.52
e. $2,634.83 b. $705.30
ANS: B c. $599.50
d. $613.61
e. $733.51
6
ANS: B on safe 10-year bonds is 6.00%, how much is the bond
42. Suppose a State of New York bond will pay $1,000 worth today?
ten years from now. If the going interest rate on these a. $2,990.20
10-year bonds is 4.1%, how much is the bond worth b. $2,512.78
today? c. $1,934.84
a. $669.10 d. $2,814.31
b. $675.79 e. $3,090.72
c. $628.96 ANS: B
d. $749.39
e. $649.03 48. Suppose the U.S. Treasury offers to sell you a
ANS: A bond for $547.25. No payments will be made until the
bond matures 5 years from now, at which time it will
43. Suppose a State of California bond will pay $1,000 be redeemed for $1,000. What interest rate would
eight years from now. If the going interest rate on you earn if you bought this bond at the offer price?
these 8-year bonds is 7.3%, how much is the bond a. 13.84%
worth today? b. 12.17%
a. $478.06 c. 11.66%
b. $631.72 d. 11.40%
c. $569.12 e. 12.81%
d. $500.82 ANS: E
e. $529.28
ANS: C 49. Suppose the U.S. Treasury offers to sell you a bond
for $3,000. No payments will be made until the bond
44. How much would $15,000 due in 50 years be matures 10 years from now, at which time it will be
worth today if the discount rate were 7.5%? redeemed for $4,600. What interest rate would you
a. $488.04 earn if you bought this bond at the offer price?
b. $310.57 a. 3.58%
c. $463.84 b. 4.32%
d. $403.34 c. 4.37%
e. $395.27 d. 5.46%
ANS: D e. 4.11%
ANS: C
45. How much would $5,000 due in 100 years be
worth today if the discount rate were 5.5%? 50. Ten years ago, Lucas Inc. earned $0.50 per share.
a. $21.75 Its earnings this year were $6.20. What was the
b. $27.66 growth rate in earnings per share (EPS) over the 10-
c. $20.81 year period?
d. $25.77 a. 26.91%
e. $23.64 b. 27.77%
c. 28.63%
ANS: E d. 21.76%
e. 29.78%
46. Suppose a U.S. treasury bond will pay $2,875 five ANS: C
years from now. If the going interest rate on 5-year
treasury bonds is 4.25%, how much is the bond worth
today?
a. $2,334.84 51. Five years ago, Weed Go Inc. earned $1.20 per
b. $2,428.24 share. Its earnings this year were $3.20. What was the
c. $2,124.71 growth rate in earnings per share (EPS) over the 5-
d. $2,381.54 year period?
e. $2,918.55 a. 21.67%
ANS: A b. 26.66%
c. 22.76%
47. Suppose an Exxon Corporation bond will pay d. 20.59%
$4,500 ten years from now. If the going interest rate e. 20.81%
7
ANS: A ANS: D

52. Janice has $5,000 invested in a bank that pays 57. You want to buy a new sports car 3 years from
5.2% annually. How long will it take for her funds to now, and you plan to save $7,400 per year, beginning
triple? one year from today. You will deposit your savings in
a. 25.36 years an account that pays 5.2% interest. How much will
b. 21.67 years you have just after you make the 3rd deposit, 3 years
c. 26.22 years from now?
d. 19.72 years a. $26,646.83
e. 20.59 years b. $19,400.76
ANS: B c. $24,776.87
d. $23,374.4
53. Bob has $2,500 invested in a bank that pays 1% e. $22,205.69
annually. How long will it take for his funds to double? ANS: D
a. 74.54 years
b. 79.41 years 58. You want to buy a new ski boat 2 years from now,
c. 73.14 years and you plan to save $5,400 per year, beginning one
d. 69.66 years year from today. You will deposit your savings in an
e. 84.99 years account that pays 6.2% interest. How much will you
ANS: D have just after you make the 2nd deposit, 2 years
from now?
54. Last year Thomson Inc's earnings per share were a. $10,133
$3.50, and its growth rate during the prior 5 years was b. $11,135
12.0% per year. If that growth rate were maintained, c. $12,582
how many years would it take for Thomson's EPS to d. $10,467
triple? e. $13,139
a. 9.69 ANS: B
b. 9.11
c. 11.25 59. You want to go to Europe 5 years from now, and
d. 10.86 you can save $8,700 per year, beginning one year
e. 10.76 from today. You plan to deposit the funds in a mutual
ANS: A fund that you think will return 8.5% per year. Under
these conditions, how much would you have just after
55. You plan to invest in securities that pay 6.2%, you make the 5th deposit, 5 years from now?
compounded annually. If you invest $5,000 today, a. $56,190.31
how many years will it take for your investment to b. $63,922.92
grow to $9,140.20? c. $40,209.58
a. 8.82 d. $41,756.10
b. 7.92 e. $51,550.74
c. 11.63 ANS: E
d. 10.03
e. 11.53 60. You want to quit your job and go back to school
ANS: D for a law degree 4 years from now, and you plan to
save $6,400 per year, beginning immediately. You will
56. You plan to invest in bonds that pay 6.0%, make 4 deposits in an account that pays 5.7% interest.
compounded annually. If you invest $10,000 today, Under these assumptions, how much will you have 4
how many years will it take for your investment to years from today?
grow to $25,000? a. $22,980.31
b. $22,685.69
a. 15.41 c. $26,221.12
b. 18.08 d. $29,461.93
c. 17.77 e. $31,524.26
d. 15.73 ANS: D
e. 14.31