Time Value of Money

TIME VALUE OF MONEY
Multiple Choice. Identify the letter of the choice that best completes the statement or answers the question.
1. 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.
2. 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.
3. A P10,000 loan is to be amortized over 5 years, with annual end-of-year payments. Given the following facts, which
of these statements is most correct?
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 5 years, and if the interest rate were the same in either
case, the first payment would include more dollars of interest under the 5-year amortization plan.
c. The last payment would have a higher proportion of interest than the first payment.
d. The proportion of interest versus principal repayment would be the same for each of the 5 payments.
e. The proportion of each payment that represents interest as opposed to repayment of principal would be
higher if the interest rate were higher.
4. If the expected rate of return on a stock exceeds the required rate,

a. The stock is experiencing supernormal growth.
b. The stock should be sold.
c. The company is probably not trying to maximize price per share.
d. The stock is a good buy.
e. Dividends are not being declared.
5. Which of the following statements is most correct?

a. The stock valuation model, P0 = D1/(ks - g), can be used for firms which have negative growth rates.
b. If a stock has a required rate of return ks = 12 percent, and its dividend grows at a constant rate of 5 percent, this
implies that the stock’s dividend yield is 5 percent.
c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
d. Statements a and c are correct.
e. All of the statements above are correct.
6. A stock’s dividend is expected to grow at a constant rate of 5 percent a year. Which of the following statements is most
correct?
a. The expected return on the stock is 5 percent a year.
b. The stock’s dividend yield is 5 percent.
c. The stock’s price one year from now is expected to be 5 percent higher.
7. Stocks A and B have the same required rate of return and the same expected year-end dividend (D1). Stock A’s dividend is
expected to grow at a constant rate of 10 percent per year, while Stock B’s dividend is expected to grow at a constant rate
of 5 percent per year. Which of the following statements is most correct?
a. The two stocks should sell at the same price.
b. Stock A has a higher dividend yield than Stock B.
c. Currently Stock B has a higher price, but over time Stock A will eventually have a higher price.
d. Statements b and c are correct.
e. None of the statements above is correct.
8. Stock X and Stock Y sell for the same price in today’s market. Stock X has a required return of 12 percent. Stock Y has a
required return of 10 percent. Stock X’s dividend is expected to grow at a constant rate of 6 percent a year, while Stock Y’s
dividend is expected to grow at a constant rate of 4 percent. Assume that the market is in equilibrium and expected returns
equal required returns. Which of the following statements is most correct?
a. Stock X has a higher dividend yield than Stock Y.
b. Stock Y has a higher dividend yield than Stock X.
c. One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
e. Statements b and c are correct.
9. Stock X is expected to pay a dividend of P3.00 at the end of the year (that is, D1 = P3.00). The dividend is expected to grow
at a constant rate of 6 percent a year. The stock currently trades at a price of P50 a share. Assume that the stock is in
equilibrium, that is, the stock’s price equals its intrinsic value. Which of the following statements is most correct?
a. The required return on the stock is 12 percent.
b. The stock’s expected price 10 years from now is P89.54.
c. The stock’s dividend yield is 6 percent.
d. Statements a and b are correct.
10. Suppose someone offered you the choice of two equally risky annuities, each paying P10,000 per year for five years.
One is an ordinary (or deferred) annuity, the other is an annuity due. Which of the following statements is most
correct?
a. The present value of the ordinary annuity must exceed the present value of the annuity due, but the future
value of an ordinary annuity may be less than the future value of the annuity due.
b. The present value of the annuity due exceeds the present value of the ordinary annuity, while the future value
of the annuity due is less than the future value of the ordinary annuity.
c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value
of the annuity due also exceeds the future value of the ordinary annuity.
d. If interest rates increase, the difference between the present value of the ordinary annuity and the present
value of the annuity due remains the same.
e. Statements a and d are correct.
11. A P10,000 loan is to be amortized over 5 years, with annual end-of-year payments. Given the following facts, which
of these statements is most correct?
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 5 years, and if the interest rate were the same in either
case, the first payment would include more dollars of interest under the 5-year amortization plan.
c. The last payment would have a higher proportion of interest than the first payment.
d. The proportion of interest versus principal repayment would be the same for each of the 5 payments.
e. The proportion of each payment that represents interest as opposed to repayment of principal would be
higher if the interest rate were higher.
12. Which of the following is most correct?
a. The present value of a 5-year annuity due will exceed the present value of a 5-year ordinary annuity. (Assume
that both annuities pay P100 per period and there is no chance of default.)
b. If a loan has a nominal rate of 10 percent, then the effective rate can never be less than 10 percent.
c. If there is annual compounding, then the effective, periodic, and nominal rates of interest are all the same.

a. An investment that compounds interest semiannually, and has a nominal rate of 10 percent, will have an
effective rate less than 10 percent.
b. The present value of a 3-year P100 annuity due is less than the present value of a 3-year P100 ordinary annuity.
c. The proportion of the payment of a fully amortized loan that goes toward interest declines over time.

a. The first payment under a 3-year, annual payment, amortized loan for P1,000 will include a smaller percentage
(or fraction) of interest if the interest rate is 5 percent than if it is 10 percent.
b. If you are lending money, then, based on effective interest rates, you should prefer to lend at a 10 percent
nominal, or quoted, rate but with semiannual payments, rather than at a 10.1 percent nominal rate with
annual payments. However, as a borrower you should prefer the annual payment loan.
c. The value of a perpetuity (say for P100 per year) will approach infinity as the interest rate used to evaluate
the perpetuity approaches zero.

a. Rising inflation makes the actual yield to maturity on a bond greater than the quoted yield to maturity, which
is based on market prices.
b. The yield to maturity for a coupon bond that sells at its par value consists entirely of an interest yield; it has a
zero expected capital gains yield.
c. On an expected yield basis, the expected capital gains yield will always be positive because an investor would
not purchase a bond with an expected capital loss.
d. The market value of a bond will always approach its par value as its maturity date approaches. This holds true
even if the firm enters bankruptcy.

a. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield
to maturity than Bond B.
b. If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.
c. If a coupon bond is selling at par, its current yield equals its yield to maturity.
17. Assume that all interest rates in the economy decline from 10 percent to 9 percent. Which of the following bonds will
have the largest percentage increase in price?
a. A 10-year bond with a 10 percent coupon.
b. An 8-year bond with a 9 percent coupon.
c. A 10-year zero coupon bond.
d. A 1-year bond with a 15 percent coupon.
e. A 3-year bond with a 10 percent coupon.
18. Which of the following has the greatest interest rate (price) risk?
a. A 10-year, P1,000 face value, 10 percent coupon bond with semiannual interest payments.
b. A 10-year, P1,000 face value, 10 percent coupon bond with annual interest payments.
c. A 10-year, P1,000 face value, zero coupon bond.
d. A 10-year P100 annuity.
e. All of the above have the same price risk since they all mature in 10 years.
19. If the yield to maturity decreased 1 percentage point, which of the following bonds would have the largest percentage
increase in value?
a. A 1-year bond with an 8 percent coupon.
b. A 1-year zero coupon bond.
c. A 10-year zero coupon bond.
d. A 10-year bond with an 8 percent coupon.
e. A 10-year bond with a 12 percent coupon.
20. If interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase
in its value?
a. A 10-year zero coupon bond.
b. A 10-year bond with a 10 percent semiannual coupon.
c. A 10-year bond with a 10 percent annual coupon.
d. A 5-year zero coupon bond.
e. A 5-year bond with a 12 percent annual coupon.
21. Which of the following Treasury bonds will have the largest amount of interest rate risk (price risk)?
a. A 7 percent coupon bond that matures in 12 years.
b. A 9 percent coupon bond that matures in 10 years.
c. A 12 percent coupon bond that matures in 7 years.
d. A 7 percent coupon bond that matures in 9 years.
e. A 10 percent coupon bond that matures in 10 years.
22. All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. If the yield to maturity on all
Treasuries were to decline to 6 percent, which of the following bonds would have the largest percentage increase in
price?
a. 15-year zero coupon Treasury bond.
b. 12-year Treasury bond with a 10 percent annual coupon.
c. 15-year Treasury bond with a 12 percent annual coupon.
d. 2-year zero coupon Treasury bond.
e. 2-year Treasury bond with a 15 percent annual coupon.

a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable
bond.
b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.
c. Reinvestment rate risk is worse from a typical investor’s standpoint than interest rate risk.
d. If a 10-year, P1,000 par, zero coupon bond were issued at a price that gave investors a 10 percent rate of
return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond
would sell at a premium over its P1,000 par value.
e. If a 10-year, P1,000 par, zero coupon bond were issued at a price that gave investors a 10 percent rate of
return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond
would sell at a discount below its P1,000 par value.

a. The market value of a bond will always approach its par value as its maturity date approaches, provided the
issuer of the bond does not go bankrupt.
b. If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably
observe an immediate increase in bond prices.
c. The total yield on a bond is derived from interest payments and changes in the price of the bond.

a. If a bond is selling for a premium, this implies that the bond’s yield to maturity exceeds its coupon rate.
b. If a coupon bond is selling at par, its current yield equals its yield to maturity.
c. If rates fall after its issue, a zero coupon bond could trade for an amount above its par value.

a. All else equal, a bond that has a coupon rate of 10 percent will sell at a discount if the required return for a
bond of similar risk is 8 percent.
b. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains
constant over time.
c. The total return on a bond for a given year consists only of the coupon interest payments received.

a. When large firms are in financial distress, they are almost always liquidated.
b. Debentures generally have a higher yield to maturity relative to mortgage bonds.
c. If there are two bonds with equal maturity and credit risk, the bond that is callable will have a higher yield to
maturity than the bond that is noncallable.
28. A 10-year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. The bond can be called in 5
years at a call price of P1,050 and the bond’s face value is P1,000. Which of the following statements is most correct?
a. The bond’s current yield is greater than 10 percent.
b. The bond’s yield to call is less than 12 percent.
c. The bond is selling at a price below par.
29. Bond X has an 8 percent annual coupon, Bond Y has a 10 percent annual coupon, and Bond Z has a 12 percent annual
coupon. Each of the bonds has a maturity of 10 years and a yield to maturity of 10 percent. Which of the following
statements is most correct?
a. Bond X has the greatest reinvestment rate risk.
b. If market interest rates remain at 10 percent, Bond Z’s price will be 10 percent higher one year from today.
c. If market interest rates increase, Bond X’s price will increase, Bond Z’s price will decline, and Bond Y’s price will
remain the same.
d. If market interest rates remain at 10 percent, Bond Z’s price will be lower one year from now than it is today.
e. If market interest rates decline, all of the bonds will have an increase in price, and Bond Z will have the largest
percentage increase in price
30. Bonds A, B, and C all have a maturity of 10 years and a yield to maturity equal to 7 percent. Bond A’s price exceeds
its par value, Bond B’s price equals its par value, and Bond C’s price is less than its par value. Which of the following
statements is most correct?
a. If the yield to maturity on the three bonds remains constant, the price of the three bonds will remain the same
over the course of the next year.
b. If the yield to maturity on each bond increases to 8 percent, the price of all three bonds will decline.
c. If the yield to maturity on each bond decreases to 6 percent, Bond A will have the largest percentage increase
in its price.
e. All of the above statements are correct.
31. Bond A has a 9 percent annual coupon, while Bond B has a 7 percent annual coupon. Both bonds have the same maturity,
a face value of P1,000, and an 8 percent yield to maturity. Which of the following statements is most correct?
a. Bond A trades at a discount, whereas Bond B trades at a premium.
b. If the yield to maturity for both bonds remains at 8 percent, Bond A’s price one year from now will be higher
than it is today, but Bond B’s price one year from now will be lower than it is today.
c. If the yield to maturity for both bonds immediately decreases to
6 percent, Bond A’s bond will have a larger percentage increase in value.
d. All of the statements above are correct.

a. Distant cash flows are generally riskier than near-term cash flows. Further, a 20-year bond that is callable after
5 years will have an expected life that is probably shorter, and certainly no longer, than an otherwise similar
noncallable 20-year bond. Therefore, investors should require a lower rate of return on the callable bond than
on the noncallable bond, assuming other characteristics are similar.
b. A noncallable 20-year bond will generally have an expected life that is equal to or greater than that of an
otherwise identical callable 20-year bond. Moreover, the interest rate risk faced by investors is greater the
longer the maturity of a bond. Therefore, callable bonds expose investors to less interest rate risk than
noncallable bonds, other things held constant.
c. Statements a and b are correct.
d. None of the statements above is correct.

a. A callable 10-year, 10 percent bond should sell at a higher price than an otherwise similar noncallable bond.
b. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not.
The difference in prices between the bonds will be greater if the current market interest rate is below the
coupon rate than if it is above the coupon rate.
c. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not.
The difference in prices between the bonds will be greater if the current market interest rate is above the
coupon rate than if it is below the coupon rate.
d. The actual life of a callable bond will be equal to or less than the actual life of a noncallable bond with the
same maturity date. Therefore, if the yield curve is upward sloping, the required rate of return will be lower
on the callable bond.
e. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise
additional funds earlier than would be true if noncallable bonds with the same maturity were used.
34. If the expected rate of return on a stock exceeds the required rate,
a. The stock is experiencing supernormal growth.
b. The stock should be sold.
c. The company is probably not trying to maximize price per share.
d. The stock is a good buy.
e. Dividends are not being declared.
35. Stock A has a required return of 10 percent. Its dividend is expected to grow at a constant rate of 7 percent per year. Stock
B has a required return of 12 percent. Its dividend is expected to grow at a constant rate of 9 percent per year. Stock A has
a price of P25 per share, while Stock B has a price of P40 per share. Which of the following statements is most correct?
a. The two stocks have the same dividend yield.
b. If the stock market were efficient, these two stocks should have the same price.
c. If the stock market were efficient, these two stocks should have the same expected return.

a. The constant growth model takes into consideration the capital gains earned on a stock.
b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes
constant.
c. Two firms with the same dividend and growth rate must also have the same stock price.

a. The stock valuation model, P0 = D1/(ks - g), can be used for firms which have negative growth rates.
b. If a stock has a required rate of return ks = 12 percent, and its dividend grows at a constant rate of 5 percent, this
implies that the stock’s dividend yield is 5 percent.
c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
38. A stock’s dividend is expected to grow at a constant rate of 5 percent a year. Which of the following statements is most
correct?
a. The expected return on the stock is 5 percent a year.
b. The stock’s dividend yield is 5 percent.
c. The stock’s price one year from now is expected to be 5 percent higher.
39. Stocks A and B have the same required rate of return and the same expected year-end dividend (D1). Stock A’s dividend is
expected to grow at a constant rate of 10 percent per year, while Stock B’s dividend is expected to grow at a constant rate
of 5 percent per year. Which of the following statements is most correct?
a. The two stocks should sell at the same price.
b. Stock A has a higher dividend yield than Stock B.
c. Currently Stock B has a higher price, but over time Stock A will eventually have a higher price.
40. Stock X has a required return of 12 percent, a dividend yield of 5 percent, and its dividend will grow at a constant rate
forever. Stock Y has a required return of 10 percent, a dividend yield of 3 percent, and its dividend will grow at a constant
rate forever. Both stocks currently sell for P25 per share. Which of the following statements is most correct?
a. Stock X pays a higher dividend per share than Stock Y.
b. Stock X has a lower expected growth rate than Stock Y.
c. One year from now, the two stocks are expected to trade at the same price.
e. Statements a and c are correct.
41. The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The
financial manager plans to issue preferred stock with a perpetual annual dividend of P5 per share and a par value of P30. If
the required return on this stock is currently 20 percent, what should be the stock’s market value?
a. P150
b. P100
c. P 50
d. P 25
e. P 10
42. Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your expectations are that you will not
receive a dividend at the end of Year 1, but you will receive a dividend of P9.25 at the end of
Year 2. In addition, you expect to sell the stock for P150 at the end of Year 2. If your expected rate of return is 16 percent,
how much should you be willing to pay for this stock today?
a. P164.19
b. P 75.29
c. P107.53
d. P118.35
e. P131.74
43. Waters Corporation has a stock price of P20 a share. The stock’s year-end dividend is expected to be P2 a share (D1 = P2.00).
The stock’s required rate of return is 15 percent and the stock’s dividend is expected to grow at the same constant rate
forever. What is the expected price of the stock seven years from now?
a. P28
b. P53
c. P27
d. P23
e. P39
44. A stock is expected to pay a dividend of P0.50 at the end of the year (i.e., D1 = 0.50). Its dividend is expected to grow at a
constant rate of 7 percent a year, and the stock has a required return of 12 percent. What is the expected price of the stock
four years from today?
a. P 5.46
b. P 9.36
c. P10.00
d. P12.18
e. P13.11
45. Albright Motors is expected to pay a year-end dividend of P3.00 a share (D1 = P3.00). The stock currently sells for P30 a
share. The required (and expected) rate of return on the stock is 16 percent. If the dividend is expected to grow at a
constant rate, g, what is g?
a. 13.00%
b. 10.05%
c. 6.00%
d. 5.33%
e. 7.00%
46. An annual coupon bond with a P1,000 face value matures in 10 years. The bond currently sells for P903.7351 and has a
9 percent yield to maturity. What is the bond’s annual coupon rate?
a. 6.7%
b. 7.0%
c. 7.2%
d. 7.5%
e. 7.7%
47. You intend to purchase a 10-year, P1,000 face value bond that pays interest of P60 every 6 months. If your nominal
annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay
for this bond?
a. P 826.31
b. P1,086.15
c. P 957.50
d. P1,431.49
e. P1,124.62
48. A corporate bond has a face value of P1,000, and pays a P50 coupon every six months (that is, the bond has a 10
percent semiannual coupon). The bond matures in 12 years and sells at a price of P1,080. What is the bond’s nominal
yield to maturity?
a. 8.28%
b. 8.65%
c. 8.90%
d. 9.31%
e. 10.78%
49. A 20-year bond with a par value of P1,000 has a 9 percent annual coupon. The bond currently sells for P925. If the
bond’s yield to maturity remains at its current rate, what will be the price of the bond 5 years from now?
a. P 966.79
b. P 831.35
c. P1,090.00
d. P 933.09
e. P 925.00
50. Consider a P1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years
remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10
percent?
a. 10.00%
b. 8.46%
c. 7.00%
d. 8.52%
e. 8.37%
51. Today is Charmaine’s 23rd birthday. Starting today, Charmaine plans to begin saving for her retirement. Her plan is to
contribute P1,000 to a brokerage account each year on her birthday. Her first contribution will take place today. Her
42nd and final contribution will take place on her 64th birthday. Her aunt has decided to help Charmaine with her savings,
which is why she gave Janet P10,000 today as a birthday present to help get her account started. Assume that the
account has an expected annual return of 10 percent. How much will Janet expect to have in her account on her 65th
birthday?
a. P 985,703.62
b. P1,034,488.80
c. P1,085,273.98
d. P1,139,037.68
e. P1,254,041.45
52. What is the present value of a 5-year ordinary annuity with annual payments of P200, evaluated at a 15 percent
interest rate?
a. P 670.43
b. P 842.91
c. P1,169.56
d. P1,348.48
e. P1,522.64
53. Today, Bruce and Brenda each have P150,000 in an investment account. No other contributions will be made to their
investment accounts. Both have the same goal: They each want their account to reach P1 million, at which time each
will retire. Bruce has his money invested in risk-free securities with an expected annual return of 5 percent. Brenda
has her money invested in a stock fund with an expected annual return of 10 percent. How many years after Brenda
retires will Bruce retire?
a. 12.6
b. 19.0
c. 19.9
d. 29.4
e. 38.9
54. An investment pays you 9 percent interest compounded semiannually. A second investment of equal risk, pays
interest compounded quarterly. What nominal rate of interest would you have to receive on the second investment
in order to make you indifferent between the two investments?
a. 8.71%
b. 8.90%
c. 9.00%
d. 9.20%
e. 9.31%
55. Today is your 21st birthday, and you are opening up an investment account. Your plan is to contribute P2,000 per year
on your birthday and the first contribution will be made today. Your 45th, and final, contribution will be made on your
65th birthday. If you earn 10 percent a year on your investments, how much money will you have in the account on
your 65th birthday, immediately after making your final contribution?
a. P1,581,590.64
b. P1,739,749.71
c. P1,579,590.64
d. P1,387,809.67
e. P1,437,809.67

Time Value of Money

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TIME VALUE OF MONEY

4. If the expected rate of return on a stock exceeds the required rate,

5. Which of the following statements is most correct?

13. Which of the following statements is most correct?

14. Which of the following statements is most correct?

15. Which of the following statements is most correct?

16. Which of the following statements is most correct?

23. Which of the following statements is most correct?

24. Which of the following statements is most correct?

25. Which of the following statements is most correct?

26. Which of the following statements is most correct?

27. Which of the following statements is most correct?

32. Which of the following statements is most correct?

33. Which of the following statements is most correct?

36. Which of the following statements is most correct?

37. Which of the following statements is most correct?

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