FIN2601 EXAM PREP Q AND A

(Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: PV and discount rate Answer: a Diff: E 1. You have determined the profitability of a planned project by finding the present value of all the cash flows from that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows? a. The discount rate decreases. b. The cash flows are extended over a longer period of time, but the total amount of the cash flows remains the same. c. The discount rate increases. d. Statements b and c are correct. e. Statements a and b are correct. Time value concepts Answer: e Diff: E 2. Which of the following statements is most correct? a. A 5-year $100 annuity due will have a higher present value than a 5-year $100 ordinary annuity. b. A 15-year mortgage will have larger monthly payments than a 30-year mortgage of the same amount and same interest rate. c. If an investment pays 10 percent interest compounded annually, its effective rate will also be 10 percent. d. Statements a and c are correct. e. All of the statements above are correct. Time value concepts Answer: d Diff: E 3. The future value of a lump sum at the end of five years is $1,000. The nominal interest rate is 10 percent and interest is compounded semiannually. Which of the following statements is most correct? a. The present value of the $1,000 is greater if interest is compounded monthly rather than semiannually. b. The effective annual rate is greater than 10 percent. c. The periodic interest rate is 5 percent. d. Statements b and c are correct. e. All of the statements above are correct. CHAPTER 6 TIME VALUE OF MONEY FIN2601 EXAM PREP Q AND A Chapter 6 - Page 2 Time value concepts Answer: d Diff: E 4. Which of the following statements is most correct? a. The present value of an annuity due will exceed the present value of an ordinary annuity (assuming all else equal). b. The future value of an annuity due will exceed the future value of an ordinary annuity (assuming all else equal). c. The nominal interest rate will always be greater than or equal to the effective annual interest rate. d. Statements a and b are correct. e. All of the statements above are correct. Time value concepts Answer: e Diff: E 5. Which of the following investments will have the highest future value at the end of 5 years? Assume that the effective annual rate for all investments is the same. a. A pays $50 at the end of every 6-month period for the next 5 years (a total of 10 payments). b. B pays $50 at the beginning of every 6-month period for the next 5 years (a total of 10 payments). c. C pays $500 at the end of 5 years (a total of one payment). d. D pays $100 at the end of every year for the next 5 years (a total of 5 payments). e. E pays $100 at the beginning of every year for the next 5 years (a total of 5 payments). Effective annual rate Answer: b Diff: E 6. Which of the following bank accounts has the highest effective annual return? a. An account that pays 10 percent nominal interest with monthly compounding. b. An account that pays 10 percent nominal interest with daily compounding. c. An account that pays 10 percent nominal interest with annual compounding. d. An account that pays 9 percent nominal interest with daily compounding. e. All of the investments above have the same effective annual return. Effective annual rate Answer: d Diff: E 7. You are interested in investing your money in a bank account. Which of the following banks provides you with the highest effective rate of interest? a. Bank 1; 8 percent with monthly compounding. b. Bank 2; 8 percent with annual compounding. c. Bank 3; 8 percent with quarterly compounding. d. Bank 4; 8 percent with daily (365-day) compounding. e. Bank 5; 7.8 percent with annual compounding. Chapter 6 - Page 3 Amortization Answer: b Diff: E 8. Your family recently obtained a 30-year (360-month) $100,000 fixed-rate mortgage. Which of the following statements is most correct? (Ignore all taxes and transactions costs.) a. The remaining balance after three years will be $100,000 less the total amount of interest paid during the first 36 months. b. The proportion of the monthly payment that goes towards repayment of principal will be higher 10 years from now than it will be this year. c. The monthly payment on the mortgage will steadily decline over time. d. All of the statements above are correct. e. None of the statements above is correct. Amortization Answer: e Diff: E 9. Frank Lewis has a 30-year, $100,000 mortgage with a nominal interest rate of 10 percent and monthly compounding. Which of the following statements regarding his mortgage is most correct? a. The monthly payments will decline over time. b. The proportion of the monthly payment that represents interest will be lower for the last payment than for the first payment on the loan. c. The total dollar amount of principal being paid off each month gets larger as the loan approaches maturity. d. Statements a and c are correct. e. Statements b and c are correct. Quarterly compounding Answer: e Diff: E 10. Your bank account pays an 8 percent nominal rate of interest. The interest is compounded quarterly. Which of the following statements is most correct? a. The periodic rate of interest is 2 percent and the effective rate of interest is 4 percent. b. The periodic rate of interest is 8 percent and the effective rate of interest is greater than 8 percent. c. The periodic rate of interest is 4 percent and the effective rate of interest is 8 percent. d. The periodic rate of interest is 8 percent and the effective rate of interest is 8 percent. e. The periodic rate of interest is 2 percent and the effective rate of interest is greater than 8 percent.