Test Bank for final Exam Chapters 6,7, 8,14 1. An ordinary annuity is best defined by which one of the following?
A. increasing payments paid for a definitive period of time
B. increasing payments paid forever
C. equal payments paid at regular intervals over a stated time period
D. equal payments paid at regular intervals of time on an ongoing basis
E. unequal payments that occur at set intervals for a limited period of time
2. Which one of the following accurately defines a perpetuity?
A. a limited number of equal payments paid in even time increments
B. payments of equal amounts that are paid irregularly but indefinitely
C. varying amounts that are paid at even intervals forever
D. unending equal payments paid at equal time intervals
E. unending equal payments paid at either equal or unequal time intervals
3. Which one of the following terms is used to identify a British perpetuity?
A. ordinary annuity
B. amortized cash flow
C. annuity due
D. discounted loan
E. consol
4. The interest rate that is quoted by a lender is referred to as which one of the following?
A. stated interest rate
B. compound rate
C. effective annual rate
D. simple rate
E. common rate
5. A monthly interest rate expressed as an annual rate would be an example of which one of the following rates?
A. stated rate
B. discounted annual rate
C. effective annual rate
D. periodic monthly rate
E. consolidated monthly rate
6. What is the interest rate charged per period multiplied by the number of periods per year called?
A. effective annual rate
B. annual percentage rate
C. periodic interest rate
D. compound interest rate
E. daily interest rate
7. A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) _____ loan.
A. amortized
B. continuous
C. balloon
D. pure discount
E. interest-only
8. Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment?
A. amortized loan
B. modified loan
C. balloon loan
D. pure discount loan
E. interest-only loan
9. Which one of the following terms is used to describe a loan wherein each payment is equal in amount and includes both interest and principal?
A. amortized loan
B. modified loan
C. balloon loan
D. pure discount loan
E. interest-only loan
10. Which one of the following terms is defined as a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum?
A. amortized loan
B. continuing loan
C. balloon loan
D. remainder loan
E. interest-only loan
11. You are comparing two annuities which offer quarterly payments of $2,500 for five years and pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while annuity B will pay you on the last day of each month. Which one of the following statements is correct concerning these two annuities?
A. These two annuities have equal present values but unequal futures values at the end of year five.
B. These two annuities have equal present values as of today and equal future values at the end of year five.
C. Annuity B is an annuity due.
D. Annuity A has a smaller future value than annuity B.
E. Annuity B has a smaller present value than annuity A.
12. You are comparing two investment options that each pay 5 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays three annual payments starting with $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options?
A. Both options are of equal value given that they both provide $12,000 of income.
B. Option A has the higher future value at the end of year three.
C. Option B has a higher present value at time zero than does option A.
D. Option B is a perpetuity.
E. Option A is an annuity.
13. You are considering two projects with the following cash flows:

Which of the following statements are true concerning these two projects?

I. Both projects have the same future value at the end of year 4, given a positive rate of return.
II. Both projects have the same future value given a zero rate of return.
III. Project X has a higher present value than Project Y, given a positive discount rate.
IV. Project Y has a higher present value than Project X, given a positive discount rate.
A. II only
B. I and III only
C. II and III only
D. II and IV only
E. I, II, and IV only
14. Which one of the following statements is correct given the following two sets of project cash flows?

A. The cash flows for Project B are an annuity, but those of Project A are not.
B. Both sets of cash flows have equal present values as of time zero given a positive discount rate.
C. The present value at time zero of the final cash flow for Project A will be discounted using an exponent of three.
D. The present value of Project A cannot be computed because the second cash flow is equal to zero.
E. As long as the discount rate is positive, Project B will always be worth less today than will Project A.
15. Which one of the following statements related to annuities and perpetuities is correct?
A. An ordinary annuity is worth more than an annuity due given equal annual cash flows for ten years at 7 percent interest, compounded annually.
B. A perpetuity comprised of $100 monthly payments is worth more than an annuity comprised of $100 monthly payments, given an interest rate of 12 percent, compounded monthly.
C. Most loans are a form of a perpetuity.
D. The present value of a perpetuity cannot be computed, but the future value can.
E. Perpetuities are finite but annuities are not.
16. Which of the following statements related to interest rates are correct?
I. Annual interest rates consider the effect of interest earned on reinvested interest payments.
II. When comparing loans, you should compare the effective annual rates.
III. Lenders are required by law to disclose the effective annual rate of a loan to prospective borrowers.
IV. Annual and effective interest rates are equal when interest is compounded annually.
A. I and II only
B. II and III only
C. II and IV only
D. I, II, and III only
E. II, III, and IV only
17. Which one of the following statements concerning interest rates is correct?
A. Savers would prefer annual compounding over monthly compounding.
B. The effective annual rate decreases as the number of compounding periods per year increases.
C. The effective annual rate equals the annual percentage rate when interest is compounded annually.
D. Borrowers would prefer monthly compounding over annual compounding.
E. For any positive rate of interest, the effective annual rate will always exceed the annual percentage rate.
18. Which one of these statements related to growing annuities and perpetuities is correct?
A. The cash flow used in the growing annuity formula is the initial cash flow at time zero.
B. Growth rates cannot be applied to perpetuities if you wish to compute the present value.
C. The future value of an annuity will decrease if the growth rate is increased.
D. An increase in the rate of growth will decrease the present value of an annuity.
E. The present value of a growing perpetuity will decrease if the discount rate is increased.
19. Which one of the following statements correctly states a relationship?
A. Time and future values are inversely related, all else held constant.
B. Interest rates and time are positively related, all else held constant.
C. An increase in the discount rate increases the present value, given positive rates.
D. An increase in time increases the future value given a zero rate of interest.
E. Time and present value are inversely related, all else held constant.
20. Which one of the following compounding periods will yield the smallest present value given a stated future value and annual percentage rate?
A. annual
B. semi-annual
C. monthly
D. daily
E. continuous
21. The entire repayment of which one of the following loans is computed simply by computing a single future value?
A. interest-only loan
B. balloon loan
C. amortized loan
D. pure discount loan
E. bullet loan
22. How is the principal amount of an interest-only loan repaid?
A. The principal is forgiven over the loan period so does not have to be repaid.
B. The principal is repaid in equal increments and included in each loan payment.
C. The principal is repaid in a lump sum at the end of the loan period.
D. The principal is repaid in equal annual payments.
E. The principal is repaid in increasing increments through regular monthly payments.
23. An amortized loan:
A. requires the principal amount to be repaid in even increments over the life of the loan.
B. may have equal or increasing amounts applied to the principal from each loan payment.
C. requires that all interest be repaid on a monthly basis while the principal is repaid at the end of the loan term.
D. requires that all payments be equal in amount and include both principal and interest.
E. repays both the principal and the interest in one lump sum at the end of the loan term.
24. You need $25,000 today and have decided to take out a loan at 7 percent for five years. Which one of the following loans would be the least expensive? Assume all loans require monthly payments and that interest is compounded on a monthly basis.
A. interest-only loan
B. amortized loan with equal principal payments
C. amortized loan with equal loan payments
D. discount loan
E. balloon loan where 50 percent of the principal is repaid as a balloon payment
25. Your grandmother is gifting you $100 a month for four years while you attend college to earn your bachelor's degree. At a 5.5 percent discount rate, what are these payments worth to you on the day you enter college?
A. $4,201.16
B. $4,299.88
C. $4,509.19
D. $4,608.87
E. $4,800.00

26. You just won the grand prize in a national writing contest! As your prize, you will receive $2,000 a month for ten years. If you can earn 7 percent on your money, what is this prize worth to you today?
A. $172,252.71
B. $178,411.06
C. $181,338.40
D. $185,333.33
E. $190,450.25

27. Phil can afford $180 a month for 5 years for a car loan. If the interest rate is 8.6 percent, how much can he afford to borrow to purchase a car?

A. $7,750.00
B. $8,348.03
C. $8,752.84
D. $9,266.67
E. $9,400.00

28. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. You can earn 6 percent on your money. Which option should you take and why?
A. You should accept the payments because they are worth $209,414 to you today.
B. You should accept the payments because they are worth $247,800 to you today.
C. You should accept the payments because they are worth $336,000 to you today.
D. You should accept the $200,000 because the payments are only worth $189,311 to you today.
E. You should accept the $200,000 because the payments are only worth $195,413 to you today.

29. Your employer contributes $75 a week to your retirement plan. Assume that you work for your employer for another 20 years and that the applicable discount rate is 7.5 percent. Given these assumptions, what is this employee benefit worth to you today?

A. $40,384.69
B. $42,618.46
C. $44,211.11
D. $44,306.16
E. $44,987.74

30. The Design Team just decided to save $1,500 a month for the next 5 years as a safety net for recessionary periods. The money will be set aside in a separate savings account which pays 4.5 percent interest compounded monthly. The first deposit will be made today. What would today's deposit amount have to be if the firm opted for one lump sum deposit today that would yield the same amount of savings as the monthly deposits after 5 years?
A. $80,459.07
B. $80,760.79
C. $81,068.18
D. $81,333.33
E. $81,548.20