FINANCE 301 EXAM #2 QUESTIONS &
VALID COMPLETE SOLUTIONS ALL
PASSED
Compounding - Correct Answer ✔✔ The arithmetic process of determining the final
value of a cash flow or series of cash flows when compound interest is applied
Compound Interest - Correct Answer ✔✔ Occurs when interest is earned on prior
periods' interest
Simple Interest - Correct Answer ✔✔ Occurs when interest is not earned on interest
Opportunity Cost - Correct Answer ✔✔ The rate of return you could earn on an
alternative investment of similar risk
Discounting
(Discounting is the reverse of compounding) - Correct Answer ✔✔ The process of
finding the present value of a cash flow or a series of cash flows
Annuity - Correct Answer ✔✔ a series of equal payments at fixed intervals for a
specified number of periods
Ordinary (Deferred) Annuity - Correct Answer ✔✔ this annuity payment occurs at the
end of each period
Annuity due - Correct Answer ✔✔ An annuity whose payments occur at the beginning
of each period
Uneven (Nonconstant) Cash Flows - Correct Answer ✔✔ A series of cash flows where
the amount varies from one period to the next
Payment (PMT) - Correct Answer ✔✔ This term designates equal cash flows coming at
regular intervals
Cash Flow - Correct Answer ✔✔ This term designates a cash flow that's not part of an
annuity
Perpetuity - Correct Answer ✔✔ A stream of equal payments at fixed intervals expected
to continue forever
Nominal (Quoted or Stated) Interest Rate - Correct Answer ✔✔ The contracted interest
rate
, Annual Percentage Rate - Correct Answer ✔✔ The periodic rate time the number of
periods per year
Effective Annual Rate - Correct Answer ✔✔ The annual rate of interest actually being
earned, as opposed to the quoted rate
Amortized loan - Correct Answer ✔✔ A loan that is repaid in equal payments over its life
Production opportunities
(4 fundamental factors) - Correct Answer ✔✔ The investment opportunities in
productive assets
Time preferences for consumption
(4 fundamental factors) - Correct Answer ✔✔ The preferences of consumers for current
consumption as opposed to saving for future consumption
Risk
(4 fundamental factors) - Correct Answer ✔✔ In a financial market context, the chance
that an investment will provide a low or negative return
Inflation
(4 fundamental factors) - Correct Answer ✔✔ The amount by which prices increase
over time
Real risk-free rate of interest, r* - Correct Answer ✔✔ The rate of interest that would
exist on default-free U.S. Treasury securities if no inflation were expected
Nominal risk-free rate rRF = r* + IP - Correct Answer ✔✔ The rate of interest on a
security that is free of all risk
Inflation premium (IP) - Correct Answer ✔✔ A premium equal to expected inflation that
investors add to the real risk-free rate of return
Default risk premium (DRP) - Correct Answer ✔✔ The difference between the interest
rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability
Liquidity Premium (LP) - Correct Answer ✔✔ a premium added to the equilibrium
interest rate on a security if that security cannot be converted to cash on short notice
and at close to its "fair market value"
Interest Rate Risk - Correct Answer ✔✔ The risk of capital losses to which investors are
exposed because of changing interest rates
Maturity Risk Premium (MRP) - Correct Answer ✔✔ a premium that reflects interest rate
risk
VALID COMPLETE SOLUTIONS ALL
PASSED
Compounding - Correct Answer ✔✔ The arithmetic process of determining the final
value of a cash flow or series of cash flows when compound interest is applied
Compound Interest - Correct Answer ✔✔ Occurs when interest is earned on prior
periods' interest
Simple Interest - Correct Answer ✔✔ Occurs when interest is not earned on interest
Opportunity Cost - Correct Answer ✔✔ The rate of return you could earn on an
alternative investment of similar risk
Discounting
(Discounting is the reverse of compounding) - Correct Answer ✔✔ The process of
finding the present value of a cash flow or a series of cash flows
Annuity - Correct Answer ✔✔ a series of equal payments at fixed intervals for a
specified number of periods
Ordinary (Deferred) Annuity - Correct Answer ✔✔ this annuity payment occurs at the
end of each period
Annuity due - Correct Answer ✔✔ An annuity whose payments occur at the beginning
of each period
Uneven (Nonconstant) Cash Flows - Correct Answer ✔✔ A series of cash flows where
the amount varies from one period to the next
Payment (PMT) - Correct Answer ✔✔ This term designates equal cash flows coming at
regular intervals
Cash Flow - Correct Answer ✔✔ This term designates a cash flow that's not part of an
annuity
Perpetuity - Correct Answer ✔✔ A stream of equal payments at fixed intervals expected
to continue forever
Nominal (Quoted or Stated) Interest Rate - Correct Answer ✔✔ The contracted interest
rate
, Annual Percentage Rate - Correct Answer ✔✔ The periodic rate time the number of
periods per year
Effective Annual Rate - Correct Answer ✔✔ The annual rate of interest actually being
earned, as opposed to the quoted rate
Amortized loan - Correct Answer ✔✔ A loan that is repaid in equal payments over its life
Production opportunities
(4 fundamental factors) - Correct Answer ✔✔ The investment opportunities in
productive assets
Time preferences for consumption
(4 fundamental factors) - Correct Answer ✔✔ The preferences of consumers for current
consumption as opposed to saving for future consumption
Risk
(4 fundamental factors) - Correct Answer ✔✔ In a financial market context, the chance
that an investment will provide a low or negative return
Inflation
(4 fundamental factors) - Correct Answer ✔✔ The amount by which prices increase
over time
Real risk-free rate of interest, r* - Correct Answer ✔✔ The rate of interest that would
exist on default-free U.S. Treasury securities if no inflation were expected
Nominal risk-free rate rRF = r* + IP - Correct Answer ✔✔ The rate of interest on a
security that is free of all risk
Inflation premium (IP) - Correct Answer ✔✔ A premium equal to expected inflation that
investors add to the real risk-free rate of return
Default risk premium (DRP) - Correct Answer ✔✔ The difference between the interest
rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability
Liquidity Premium (LP) - Correct Answer ✔✔ a premium added to the equilibrium
interest rate on a security if that security cannot be converted to cash on short notice
and at close to its "fair market value"
Interest Rate Risk - Correct Answer ✔✔ The risk of capital losses to which investors are
exposed because of changing interest rates
Maturity Risk Premium (MRP) - Correct Answer ✔✔ a premium that reflects interest rate
risk
