Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 5 Interest Rates
5.1 Interest Rate Quotes and Adjustments
1) When you borrow money, the interest rate on the borrowed money is the price you pay
to be able to convert your future loan payments into money today.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
2) When there are large numbers of people looking to save their money and there is little
demand for loans, one would expect interest rates to be high.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
3) The annual percentage rate indicates the amount of interest, including the effect of any
compounding.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
4) Which of the following would be LEAST likely to lower the interest rate that a bank
offers a borrower?
A) The number of borrowers seeking funds is low.
B) The expected inflation rate is expected to be low.
C) The borrower is judged to have a low degree of risk.
D) The loan will be for a long period of time.
Answer: D
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Revised
1
Copyright © 2015 Pearson Education, Inc.
,5) What is the effective annual rate (EAR)?
A) It is the interest rate that would earn the same interest with annual compounding.
B) It is the ratio of the number of the annual percentage rate to the number of
compounding periods per year.
C) It is the interest rate for an n-year time interval, where n may be more than one year or
less than or equal to one year (a fraction).
D) It refers to the cash flows from an investment over a one-year period divided by the
number of times that interest is compounded during the year.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) A bank offers a loan that will requires you to pay 7% interest compounded monthly.
Which of the following is closest to the EAR charged by the bank?
A) 5.78%
B) 8.68%
C) 7.23%
D) 14.46%
Answer: C
Explanation: C) EAR = {(1 + APR) / m}m - 1;
Diff: 1 Var: 20
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) A bank pays interest semiannually with an EAR of 13%. What is the periodic interest rate
applicable semiannually?
A) 5.04%
B) 7.56%
C) 6.30%
D) 12.60%
Answer: C
Explanation: C) First convert the EAR to APR with semiannually compounding, which
equals 12.60%; now divide this by 2 to get the periodic interest
Diff: 1 Var: 30
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2
Copyright © 2015 Pearson Education, Inc.
,8) Howard is saving for a holiday. He deposits a fixed amount every month in a bank
account with an EAR of 14.7%. If this account pays interest every month then how much
should he save from each monthly paycheck in order to have $14,000 in the account in four
years' time?
A) $176
B) $308
C) $220
D) $352
Answer: C
Explanation: C) First calculate the APR using an EAR of 14.7% and monthly compounding,
which comes to 13.7937%. Then using a periodic rate of 13.7937/12, calculate the payment
over 48 months that gives a future value (FV) of $14,000, which is $110.15.
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Reflective Thinking Skills
Author: DS
Question Status: Revised
9) A(n) 12% APR with monthly compounding is closest to ________.
A) an EAR of 10.14%
B) an EAR of 15.22%
C) an EAR of 12.68%
D) an EAR of 25.36%
Answer: C
Explanation: C)
Diff: 1 Var: 20
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
10) Which of the following best describes the annual percentage rate?
A) the quoted interest rate which, considered with the compounding period, gives the
effective interest rate
B) the effective annual rate, after compounding is taken into account
C) the discount rate, when compounded more than once a year or less than once a year
D) the discount rate, when effective annual rate is divided by the number of times it is
compounded in a year
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3
Copyright © 2015 Pearson Education, Inc.
, 11) An animator needs a laptop for audio/video editing, and notices that he can pay $2600
for a Dell XPS laptop, or lease from the manufacturer for monthly payments of $75 each for
four years. The designer can borrow at an interest rate of 14% APR compounded monthly.
What is the cost of leasing the laptop over buying it outright?
A) Leasing costs $116 more than buying.
B) Leasing costs $174 more than buying.
C) Leasing costs $145 more than buying.
D) Leasing costs $289 more than buying.
Answer: C
Explanation: C) Using a periodic rate of 14% / 12 per month, calculate the present value
(PV) of an annuity of $75 for 48 months; then subtract $2600 to calculate the difference in
costs.
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
12) Which of the following accounts has the highest EAR?
A) one that pays 5.4% every six months
B) one that pays 1.0% per month
C) one that pays 9.6% per year
D) one that pays 2.4% every three months
Answer: B
Explanation: B) Calculate the EAR for each choice and pick the highest:
Diff: 2 Var: 4
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
13) Drew receives an inheritance that pays him $54,000 every three months for the next
two years. Which of the following is closest to the present value (PV) of this inheritance if
the interest rate is 8.9% (EAR)?
A) $314,366
B) $471,549
C) $392,957
D) $432,000
Answer: C
Explanation: C) First calculate the APR with quarterly compounding, which equals 8.62%;
then using a periodic interest rate of 8.62/4%, calculate the present value (PV) of an
annuity of $54,000 for eight periods.
Diff: 3 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4
Copyright © 2015 Pearson Education, Inc.
Chapter 5 Interest Rates
5.1 Interest Rate Quotes and Adjustments
1) When you borrow money, the interest rate on the borrowed money is the price you pay
to be able to convert your future loan payments into money today.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
2) When there are large numbers of people looking to save their money and there is little
demand for loans, one would expect interest rates to be high.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
3) The annual percentage rate indicates the amount of interest, including the effect of any
compounding.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Previous Edition
4) Which of the following would be LEAST likely to lower the interest rate that a bank
offers a borrower?
A) The number of borrowers seeking funds is low.
B) The expected inflation rate is expected to be low.
C) The borrower is judged to have a low degree of risk.
D) The loan will be for a long period of time.
Answer: D
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Revised
1
Copyright © 2015 Pearson Education, Inc.
,5) What is the effective annual rate (EAR)?
A) It is the interest rate that would earn the same interest with annual compounding.
B) It is the ratio of the number of the annual percentage rate to the number of
compounding periods per year.
C) It is the interest rate for an n-year time interval, where n may be more than one year or
less than or equal to one year (a fraction).
D) It refers to the cash flows from an investment over a one-year period divided by the
number of times that interest is compounded during the year.
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) A bank offers a loan that will requires you to pay 7% interest compounded monthly.
Which of the following is closest to the EAR charged by the bank?
A) 5.78%
B) 8.68%
C) 7.23%
D) 14.46%
Answer: C
Explanation: C) EAR = {(1 + APR) / m}m - 1;
Diff: 1 Var: 20
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) A bank pays interest semiannually with an EAR of 13%. What is the periodic interest rate
applicable semiannually?
A) 5.04%
B) 7.56%
C) 6.30%
D) 12.60%
Answer: C
Explanation: C) First convert the EAR to APR with semiannually compounding, which
equals 12.60%; now divide this by 2 to get the periodic interest
Diff: 1 Var: 30
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2
Copyright © 2015 Pearson Education, Inc.
,8) Howard is saving for a holiday. He deposits a fixed amount every month in a bank
account with an EAR of 14.7%. If this account pays interest every month then how much
should he save from each monthly paycheck in order to have $14,000 in the account in four
years' time?
A) $176
B) $308
C) $220
D) $352
Answer: C
Explanation: C) First calculate the APR using an EAR of 14.7% and monthly compounding,
which comes to 13.7937%. Then using a periodic rate of 13.7937/12, calculate the payment
over 48 months that gives a future value (FV) of $14,000, which is $110.15.
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Reflective Thinking Skills
Author: DS
Question Status: Revised
9) A(n) 12% APR with monthly compounding is closest to ________.
A) an EAR of 10.14%
B) an EAR of 15.22%
C) an EAR of 12.68%
D) an EAR of 25.36%
Answer: C
Explanation: C)
Diff: 1 Var: 20
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
10) Which of the following best describes the annual percentage rate?
A) the quoted interest rate which, considered with the compounding period, gives the
effective interest rate
B) the effective annual rate, after compounding is taken into account
C) the discount rate, when compounded more than once a year or less than once a year
D) the discount rate, when effective annual rate is divided by the number of times it is
compounded in a year
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3
Copyright © 2015 Pearson Education, Inc.
, 11) An animator needs a laptop for audio/video editing, and notices that he can pay $2600
for a Dell XPS laptop, or lease from the manufacturer for monthly payments of $75 each for
four years. The designer can borrow at an interest rate of 14% APR compounded monthly.
What is the cost of leasing the laptop over buying it outright?
A) Leasing costs $116 more than buying.
B) Leasing costs $174 more than buying.
C) Leasing costs $145 more than buying.
D) Leasing costs $289 more than buying.
Answer: C
Explanation: C) Using a periodic rate of 14% / 12 per month, calculate the present value
(PV) of an annuity of $75 for 48 months; then subtract $2600 to calculate the difference in
costs.
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
12) Which of the following accounts has the highest EAR?
A) one that pays 5.4% every six months
B) one that pays 1.0% per month
C) one that pays 9.6% per year
D) one that pays 2.4% every three months
Answer: B
Explanation: B) Calculate the EAR for each choice and pick the highest:
Diff: 2 Var: 4
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
13) Drew receives an inheritance that pays him $54,000 every three months for the next
two years. Which of the following is closest to the present value (PV) of this inheritance if
the interest rate is 8.9% (EAR)?
A) $314,366
B) $471,549
C) $392,957
D) $432,000
Answer: C
Explanation: C) First calculate the APR with quarterly compounding, which equals 8.62%;
then using a periodic interest rate of 8.62/4%, calculate the present value (PV) of an
annuity of $54,000 for eight periods.
Diff: 3 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4
Copyright © 2015 Pearson Education, Inc.
