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Homework answers / question archive / University of San Carlos - Main Campus ACCTG 509 Chapter 2 True/False Questions 1)The real interest rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption

University of San Carlos - Main Campus ACCTG 509 Chapter 2 True/False Questions 1)The real interest rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption

Accounting

University of San Carlos - Main Campus

ACCTG 509

Chapter 2

True/False Questions

1)The real interest rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.

 

 

  1. At a peak in economic activity the term structure usually switches from a downward slope to flat.

 

  1. A monthly interest rate of 1% is equivalent to a 12% annual interest rate with annual compounding.

 

  1. In simple interest calculations the interest earned is never added to the principle.

 

  1. Cash flows of $500 in one month, $500 in 3 months and $500 in 6 months comprise an annuity.

 

  1. You just won a lottery that has a present value of $20 million. However, you will actually receive 20 annual installment payments over the next 20 years, beginning in one year. If the interest rate is greater than zero you can expect each installment to be less than $1 million.

 

 

  1. Everything else equal, the present value of a given future cash flow will increase if you use a higher interest rate while the future value of a given amount of cash received today will decrease if you use a higher interest rate.

 

 

  1. Holding everything else equal, for a given N year annuity, the higher the interest rate the greater the future value of the annuity and the lower the present value of the annuity.

 

 

  1. If you buy a single payment security you will receive interest in 6 months and at maturity.

 

  1. Everything else equal, a bond equivalent yield will be greater than an effective annual yield

 

  1. The household sector is the largest supplier of loanable funds.  

 

  1. The greater is household wealth, the greater the amount of loanable funds they demand, ceteris paribus.

 

  1. An increase in the perceived riskiness of investments would cause a movement up along the supply curve.

 

 

  1. Ceteris paribus, a decline in the government budget deficit would tend to increase U.S. interest rates.

 

  1. When the quantity of a financial security supplied or demanded changes at every given interest rate in response to a change in a factor, this causes a shift in the supply or demand curve.

 

 

  1. An increase in loan origination fees by all banks would shift the demand for funds up and to the left.

 

  1. An improvement in economic conditions would likely shift the supply curve down and to the right and shift the demand curve for funds up and to the right.

 

 

  1. The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called default risk.

 

 

  1. The nominal rate less the DRP is the real rate.

 

  1. Default risk premiums on investment grade debt typically increase during economic slowdowns.

 

  1. Everything else equal, the interest rate on a callable bond will be less than the interest rate on a convertible bond.

 

 

  1. The term structure of interest rates is the relationship between interest rates on bonds similar in terms except for maturity.

 

 

  1. The unbiased expectations hypothesis of the term structure posits that long term interest rates are unrelated to expected future short term rates.

 

 

  1. The traditional liquidity premium theory states that long term interest rates are greater than the average of expected future interest rates.

 

 

  1. According to the market segmentation theory short term investors will not normally switch to intermediate or long term investments.

 

 

Multiple Choice Questions

  1. An investment pays, $950 in one year, X amount of dollars in two years and $450 in 3 years. The total present value of all the cash flows (including X) is equal to $2000. If it is 9%, what is X?

 

A) $817.16

B) $749.68

C) $780.95

 

D) $927.86

E) $600.00

 

 

 

  1. An annuity and an annuity due that have the same number of payments also have the same present value if r = 10%. Which one has the higher payment?
    1. The annuity has the higher payment
    2. The annuity due has the higher payment
    3. They both must have the same payment since the present values are the same
    4. There is no way to tell which has the higher payment
    5. An annuity and an annuity due cannot have the same present value

 

 

 

  1. A 10 payment annual annuity has its first payment in 6 years. The investment has a current value today of $50,000. What is the payment amount (to the penny) if the interest rate is 12%?

 

A) $15,364.55

B) $8,849.21

C) $14,490.25

D) $17,651.20

E) $15,595.33

 

 

 

  1. You borrow $95 today for six and a half weeks. You must repay $100 at loan maturity. What is the effective annual rate on this loan?

A) 50.73%

B) 40.00%

C) 32.33%

D) 27.95%

E) 37.93%

 

 

 

  1. If M > 1 and you solve the following equation to find i: PV * (1 + (i/M))M*N = FV, the i you get will be

 

    1. The bond equivalent yield
    2. The EAR
    3. The TOE
    4. The EYE

 

    1. The rate per compounding period

 

 

 

  1. An annuity and an annuity due with the same number of payments have the same future value if r = 10%. Which one has the higher payment?
    1. They both must have the same payment since the future values are the same
    2. There is no way to tell which has the higher payment
    3. An annuity and an annuity due cannot have the same future value
    4. The annuity has the higher payment
    5. The annuity due has the higher payment

 

 

 

  1. You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may perhaps be explained by which one of the following:
    1. A decrease in U.S. inflationary expectations
    2. Newly expected decline in the value of the dollar
    3. An increase in current and expected future returns of real corporate investments
    4. Decreased Japanese purchases of U.S. Treasury Bills/Bonds
    5. Increases in the U.S. Government budget deficit

 

 

 

Use the following to answer questions 33-34:

 

Y I E L D

C

U

R V E

F O

R

Z E R O                          C O

U

P O N

B

O

N

D S

R

M a t u r  i t y

 

 

Y T M

 

 

M a t u r i t y

 

Y T M

 

 

 

M

a t u

1 y e a r

8 . 0 0 %

7

y e a r

9 . 1 5 %

1 3

y e

2 y e a r

8 . 1 1 %

8

y e a r

9 . 2 5 %

1 4

y e

3 y e a r

8 . 2 0 %

9

y e a r

9 . 3 5 %

1 5

y e

4 y e a r

8 . 5 0 %

1 0

y e a r

9 . 4 7 %

1 6

y e

5 y e a r

8 . 7 5 %

1 1

y e a r

9 . 5 2 %

1 7

y e

6 y e a r

8 . 8 5 %

1 2

y e a r

9 . 7 7 %

1 8

y e

                             
  1. To the nearest basis point what is the expected interest rate on a one year AA zero coupon bond purchased eight years from today?

 

A) 9.47%

B) 10.15%

 

C) 9.41%

D) 10.56%

 

E) 0.12%

 

 

 

  1. You just bought a 17 year maturity Xerox corporate bond rated AA with a 0% coupon. Find the expected rate of return (to the nearest basis point) on the bond if you expect to sell the bond in 6 years (watch out for rounding error).

 

A) 11.00%

B) 8.85%

 

C) 12.39%

D) 9.80%

 

E) 9.92%

 

 

 

  1. According to the liquidity premium theory of interest rates
    1. Long term spot rates are higher than the average of current and expected future short term rates.
    2. Investors prefer certain maturities and will not normally switch out of those maturities.
    3. Investors are indifferent between different maturities if the long term spot rates are equal to the average of current and expected future short term rates.
    4. The term structure must always be upward sloping.
    5. Long term spot rates are totally unrelated to expectations of future short term rates.  

 

 

  1. An increase in income tax rates
    1. Will decrease the savings rate
    2. Will decrease the supply of loanable funds
 

 

    1. Will increase interest rates
    2. All of the above

 

 

 

  1. Upon graduating from college this year you expect to earn $25,000 per year. If you get your MBA, in one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5%. In today's dollars, how much additional (less) money will you make from getting your MBA (to the nearest dollar) in your first year?

 

A) -$2,462

B) $8,333

 

 

C) $8,750

D) $9,524

 

E) $10,000

 

 

  1. Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% interest for 10 years.

Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to

               (to the nearest penny).

 

A) $2,500.00

B) -$2,500.00

 

 

C) $1,643.32

D) $3,094.67

 

E) -$3,094.67

 

 

  1. If a $10,000 par T-Bill has a 9.5% discount and a 180 day maturity, what is the price of the T-Bill?

 

A) $9,050

B) $9,525

 

 

C) $9,532

D) $9,675

 
  1. None of the above

 

 

  1. A 90 day T-Bill is selling for $9,825. The par is $10,000. The EAR on the T-Bill is

 

A) 7.00%

B) 7.22%

 

C) 7.29%

D) 7.42%

 

E) 7.54%

 

  

 

  1. Suppose that $10 million face value commercial paper with a 270 day maturity is selling for $9.5 million. What is the EAR on the paper?

 

A) 5.26%

B) 7.11%

 

C) 7.32%

D) 9.45%

 

E) None of the above

 

 

 

  1. A $1 million jumbo CD is quoting a 6.25% interest rate on 180 day maturity CDs. How much money could you withdraw in 180 days if you invest in the CD?

 

A) $1,000,000

B) $1,062,500

 

C) $1,031,250

D) $1,030,822

 

E) None of the above

 

 

 

  1. An investor wants to be able to buy 4% more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2%. Which statement(s) below is/are true.
  1. 4% is the desired real rate of interest
  2. 6% is the approximate nominal rate of interest required

 

  1. 2% is the expected inflation rate over the period

 

  1. I only
  2. II only

 

 
  1. III only
  2. I and II only
 
  1. I, II and III are true

 

 

  1. Classify each of the following in terms of their effect on interest rates (increase or decrease):
  1. Perceived risk of financial securities increases
  2. Near term spending needs decrease
  3. Future profitability of real investments increases

 

  1. I increases, II increases, III increases
  2. I increases, II decreases, III
 

decreases

  1. I decreases, II increases, III increases
  2. I decreases, II
 

decreases, III decreases

  1. None of the above

 

 

 

  1. Classify each of the following in terms of their effect on interest rates (increase or decrease):
  1. Covenants on borrowing become more restrictive
  2. The Federal Reserve increases the money supply
  3. Total household wealth increases

 

  1. I increases, II increases, III increases
  2. I increases, II decreases, III decreases
  3. I decreases, II increases, III increases  
 
  1. I decreases, II decreases, III decreases
  2. None of the above

 

 

  1. Inflation causes the demand curve for loanable funds to shift to the                      and causes the supply curve to shift to the                                                                                                         .

 

    1. Right; right
    2. Right; left

 

 
    1. Left; left
    2. Left; right

 

 

  1. An individual desires to earn a real return of 3%. Prices are expected to rise over the investment period by 4%. The investor has a federal tax rate of 28% and state and local tax rate of 6%, what is the investor's expected after tax rate of return?

 

A) 7.006%

B) 10.61%

 

C) 5.04%

D) 4.62%

 

E) 6.58%

 

 

 

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