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Chap 004 Students
Chap 004 Students
Chap 004 Students
2. The future value of $100 at a 5% per year interest rate at the end
of one year is:
A) $95.00
B) $105.00
C) $97.50
D) None of the above.
11. Suppose Tom receives a one year simple loan from ABC Bank for
$5000.00. At the end of the year, Tom repays $5400.00 to ABC
Bank. The interest rate on Tom's loan was:
A) $400
B) 8.00%
C) 7.41%
D) None of the above
16. Suppose Paul borrows $4000 for one year from his grandfather who
charges Paul 7% interest. At the end of the year Paul will have to
repay his grandfather:
A) $4,280
B) $4,290
C) $4,350
D) None of the above
18. A saver knows that she will receive $100 from the bank one year
from now, this includes the interest she will earn. What is the
interest rate she is earning if she put $95 in the bank today?
A) 5.10%
B) 6.00%
C) 5.52%
D) 5.26%
E) None of the above
19. Tom deposits funds in his savings account at the bank which is
paying 3.5% interest. If he keeps his funds in the bank for one year
he will have $155.25. What amount is Tom depositing?
A) $151.75
B) $150.00
C) $148.75
D) $147.50
23. The value of $100 left in a savings account earning 5% a year, will
be worth what amount after ten years?
A) $150.00
B) $160.50
C) $159.84
D) $162.89
30. What is the future value of $1000 after six months earning 12%
annually?
A) $1050.00
B) $1060.00
C) $1120/2
D) $1058.30
63. If the internal rate of return from an investment is more than the
opportunity cost of funds:
A) The firm should make the investment.
B) The firm should not make the investment.
C) The firm should only make the investment using retained
earnings.
D) None of the above.
78. Which formula below best expresses the real interest rate, (r)?
A) i = r – πe
B) r = i + πe
C) r = i – πe
D) πe = i + r
79. A borrower who makes a $1000 loan for one year and earns interest
in the amount of $75, earns what nominal interest rate and what
real interest rate if inflation is two percent?
A) A nominal rate of 5.5% and a real rate of 2.0%
B) A nominal rate of 7.5% and a real rate of 5.0%
C) A nominal rate of 7.5% and a real rate of 9.5%
D) A nominal rate of 7.5% and a real rate of 5.5%
89. If the interest rate is 4%, the present value of an investment that
pays $100,000 a year forever is:
A) $4,000,000
B) $25,000,000
C) $400,000
D) $2,500,000
90. A lender expects to earn a real interest rate of 4.5% over the next
12 months. She charges a 9.25% (annual) nominal rate for a 12
month loan. What inflation rate is she expecting? If the lender is in
a 30% marginal tax bracket and the borrower is in a 25% marginal
tax bracket, what was the real after tax rates each expects?
Answer: For the first part she expected an inflation rate of 4.75%.
We obtain this answer using the Fisher equation where i = r + πe.
For the second part we need to use a variation of the Fisher
equation. The lender receives an after-tax nominal rate of 6.475%
from which we subtract the inflation rate of 4.75% and the lender
expects a real after-tax rate of 1.725%. The borrower expects to
pay an after-tax real rate of 2.188%.
LOD: 3 Page: 84
A-Head: Real and Nominal Interest Rates.
91. Compute the yield for a $1000 face value zero coupon bond that
sells for $280 and matures in 20 years.
98. What will be the amount owed at the end of one year if a borrower
charges $100 on her credit card and doesn't make any payments
during the year if the interest rate is 1.5% per month?
99. Which investment plan will provide the highest future value: $500
invested at 5 percent annually for four years and then that balance
invested at 7 percent annually for an additional three years. Or
$500 invested at 6 percent annually for seven years?
Answer: $500 invested for four years at 5 percent interest and then
that balance invested at 7% for three additional years will produce
a balance of $744.52 at the end of seven years. $500 invested for
seven years at 6 percent interest produces $752.82. LOD: 3
Page: 75
A-Head: Applying Present Value.
101. An investment grows from $2000 to $2750 over the period of 10
years. What average annual growth rate will produce this result?
Answer: To solve this we equate the cost of the machine to the sum
of the present value for each annual payment and solve for the
interest rate. Using a financial calculator or a spreadsheet we
obtain an internal rate of return of 4.85%.
LOD: 3 Page: 73
A-Head: Applying Present Value.
104. You win your state lottery. The lottery officials offer you the
following option, you can accept annual payments of $50,000 for 20
years or receive an upfront payment of $700,000. Ignoring issues
like mortality tables, taxes, etc. What market interest rate has you
taking the upfront payment?
105. You are considering purchasing a home. You find one that you like
but you realize that you will need to obtain a mortgage for
$100,000. The mortgage company presents you with two options, a
15 year mortgage at a 6.0% annual rate and a 30 year mortgage at
a 6.5% annual rate. What will be the fixed annual payment for each
mortgage?
Answer: Realizing that the price of the bond is the sum of the
present value of all payments we simply calculate the present value
of each payment and sum these. With the help of a financial
calculator or a spreadsheet if necessary, we see the value of the
bond is $1081.10.
LOD: 3 Page: 79
A-Head: Applying Present Value.
108. A bond offers a $40 coupon, has a face value of $1000, and 10
years to maturity. If the interest rate is 5.0%, what is the value of
this bond?
Answer: Realizing that the price of the bond is the sum of the
present value of all payments we simply calculate the present value
of each payment and sum these. With the help of a financial
calculator or spreadsheet if necessary, we see the value of the
bond is $922.78.
LOD: 3 Page: 79
A-Head: Applying Present Value.
111. Explain why, if real interest rates are so important, we see most
interest rates quoted in nominal terms.