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FIN 534 PART 2 MIDTERM

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FIN 534 PART 2 MIDTERM QUESTION 1 Which of the following statements is CORRECT? Answer If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. The cash flows for an annuity due must all occur at the beginning of the periods. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month. Question 2 A $150,000 loan is to be amortized over 6 years, with annual end-of-year payments. Which of these statements is CORRECT? Answer The proportion of interest versus principal repayment would be the same for each of the 7 payments. The annual payments would be larger if the interest rate were lower. If the loan were amortized over 10 years rather than 6 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 6-year amortization plan. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. Question 3 Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures? Answer $3,754.27 $3,941.99 $4,139.09 $4,346.04 $4,563.34 Question 4 You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment? Answer The discount rate increases. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000. The discount rate decreases. The riskiness of the investment’s cash flows increases. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years. QUESTION 5 Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? Question 6 A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? Answer The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity. The periodic interest rate is greater than 3%. The periodic rate is less than 3%. The present value would be greater if the lump sum were discounted back for more periods. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually. Question 7 The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT? Answer Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year. Bond A sells at a discount (i

FIN 534 PART 2 MIDTERM

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