M and B 3 3rd Edition Dean Croushore Test Bank 1

M and B 3 3rd Edition Dean Croushore
Test Bank
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1. The amount of money invested in a financial security or deposited into a financial intermediary is referred to as the
a. principal.
b. interest.
c. yield.
d. capital-gain.
ANSWER: a
POINTS: 1
DIFFICULTY: Moderate
TOPICS: The Present Value of One Future Payment
OTHER: Conceptual
2. The amount of money that you would need to invest today to yield a given future amount is called the
a. future value.
b. present value.
c. rate of discount.
d. discount factor.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
3. If the principal invested in a bank at an annual interest rate of 6% is $3,000, the interest that will accumulate on the
principal after a year will equal
a. $180.
b. $300.
c. $500.
d. $700.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
4. If the interest accumulated on a principal amount of $5,000 at the end of a year is $400, the annual rate of interest
must be
a. 4%.
b. 6%.
c. 8%.
d. 20%.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Present Value of one Future Payment
OTHER: Conceptual
5. Earning interest on the interest that was earned in prior years is referred to as
a. discounting.
b. compounding.
c. present valuing.
d. bonding.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
6. In the one-period present-value equation, P = F/(1 + i), the term 1 + i is referred to as

a. future value.
b. present value.
c. the rate of discount.
d. the discount factor.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
7. In the one-period present-value equation, P = F/(1 + i), the term i is known as
a. future value.
b. present value.
c. the rate of discount.
d. the discount factor.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
8. Discounting is the process of dividing a future value by the to obtain the value.
a. discount factor; past
b. discount factor; present
c. rate of discount; past
d. rate of discount; present
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
9. Which of the following statements is true?

a. Everything else remaining unchanged, higher the future value of an investment, higher will be the present
value.
b. Everything else remaining unchanged, higher the rate of discount on an investment, higher will be the present
value.
c. The future value of an investment is unrelated to the principal amount invested.
d. The future value of an investment is unrelated to the ongoing rate of interest.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
10. The present value of a security is
a. directly related to the discount rate.
b. inversely related to the time until maturity.
c. directly related to the principal amount.
d. is not related to the discount rate.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
11. The present value of a series of future payments is

a. inversely related to the future value.
b. unrelated to the discount factor.
c. inversely related to the rate of discount.
d. directly related to the discount factor.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
12. Which of the following options would you choose to have if the rate of discount is 20 percent?
a. $300 in one year b.
$350 in two years c.
$420 in three years d.
$1500 in ten years
ANSWER: a
POINTS: 1
OTHER: Conceptual
13. If the present value of $3,000 to be received after a year is $2,795, the annual rate of discount must be
a. 5.65%.
b. 7.33%.
c. 9%.
d. 11.11%.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
14. A debt security with just one payment at a future date is referred to as a
a. coupon bond.
b. fixed-payment security.
c. discount bond.
d. perpetuity.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
15. Treasury bills issued by the U.S. government that mature in a year or less are similar to
a. perpetuities.
b. discount bonds.
c. coupon bonds.
d. fixed-income securities.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
16. Consider a one-year discount bond that pays $1,000 at maturity. If the annual rate of discount is 7 percent, the
present value of the bond is
a. $930.00.
b. $934.58.
c. $993.00.
d. $993.46.
ANSWER: b
POINTS: 1
OTHER: Conceptual
17. Consider a one-year discount bond that pays $1,500 one year from now. If the annual rate of discount is 4 percent,
the present value of the bond is
a. $1,560.00.
b. $1,540.00.
c. $1,440.00.
d. $1,442.31.
ANSWER: d
POINTS: 1
OTHER: Conceptual
18. Consider a bond that has a present value of $1,000. If the annual rate of interest is 7 percent, the future value of the
bond after a year is
a. $930.00.
b. $934.58.
c. $1,000.00.
d. $1,070.00.
ANSWER: d
POINTS: 1
OTHER: Conceptual
19. Consider a bond that has a present value of $1,500. If the annual rate of interest is 4 percent, the future value of the
bond after a year is
a. $1,560.00.
b. $1,540.00.
c. $1,440.00.
d. $1,442.31.
ANSWER: a
POINTS: 1
OTHER: Conceptual
20. The equation that allows us to compare dollar amounts to be received at different dates is the
a. present-value formula.
b. Taylor rule.
c. interest-rate parity equation.
d. Roy's identity
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The General Form of the Present-Value Formula
OTHER: Factual
21. A debt security that pays interest forever and never repays the principal is a
a. fiduciary obligation.
b. federal funds loans.
c. perpetuity.
d. junk bond.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
22. Which of the following statements is true?

a. A coupon bond is a debt security with only one payment.
b. The amount invested in a financial security is referred to as perpetuity.
c. A coupon bond is a debt security that pays interest forever and never repays principal.
d. The present value of a perpetuity varies directly with the annual repayments.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
23. The present value of a perpetuity that pays $F every year when the annual rate of discount is i is
a. F/(1 + i).
b. F×i.
c. F/i.
d. F + i.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
24. Which of the following statements is true of a perpetuity?
a. A perpetuity has a fixed maturity.
b. The present value of each payment made by a perpetuity is less than the previous payment.
c. The present value of a perpetuity that pays $100 every year when the annual rate of discount is 5% is $1,000.
d. The present value of a perpetuity that pays $200 every year when the annual rate of discount is 7% is $1,750.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
25. The difference between the present value of a perpetuity that pays $250 every year and a perpetuity that pays $500
every year when the annual rate of discount is 5% is
a. $500.
b. $750.
c. $5,000.
d. $7,500.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
26. Consider a perpetuity that pays $100 every year. If the annual rate of discount is 7 percent, the present value of the
perpetuity is
a. $107.00.
b. $1,300.00.
c. $1,428.57.
d. $1,700.00.
ANSWER: c
POINTS: 1
OTHER: Conceptual
27. Consider a perpetuity that pays $150 every year. If the annual rate of discount is 4 percent, the present value of the
perpetuity is
a. $210.00.
b. $3,000.00.
c. $3,600.00.
d. $3,750.00.
ANSWER: d
POINTS: 1
OTHER: Conceptual
28. Consider a perpetuity making one payment each year that has a present value of $1,000. If the annual rate of
discount is 7 percent, the annual payment is
a. $70.00.
b. $107.00.
c. $1,428.57.
d. $14,285.71.
ANSWER: a
POINTS: 1
OTHER: Conceptual
29. Consider a perpetuity making one payment each year that has a present value of $1,500. If the annual rate of
discount is 3 percent, the annual payment is
a. $15.00.
b. $45.00.
c. $500.00.
d. $1,500.00.
ANSWER: b
POINTS: 1
OTHER: Conceptual
30. The process in which the principal amount of a security is repaid gradually over time is referred to as
a. securitization.
b. depreciation.
c. amortization.
d. discounting.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
31. After amortizing the principal, a debt security that makes the same dollar payment every year is referred to as a
a. coupon bond.
c. discount bond.
d. perpetuity.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
32. Consider a fixed-payment security that pays $100 at the end of every year for three years. If the annual rate of
discount is 10 percent, the present value of the security is
a. $24.87.
b. $248.69.
c. $294.10.
d. $1,000.00.
ANSWER: b
POINTS: 1
OTHER: Conceptual
33. A bond that makes a regular interest payment until maturity, at which time the face value is repaid is referred to as a
a. coupon bond.
c. discount bond.
d. perpetuity.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
34. Consider a three-year fixed-payment security that has a present value of $1,000. If the annual rate of discount is 7
percent, the payment made at the end of each year is
a. $70.00.
b. $107.00.
c. $142.86.
d. $381.05.
ANSWER: d
POINTS: 1
OTHER: Conceptual
35. Consider a fixed-payment security that pays $100 at the end of every year for five years. If the annual rate of
discount is 7 percent, the present value of the security is
a. $142.64.
b. $410.02.
c. $789.34.
d. $999.63.
ANSWER: b
POINTS: 1
OTHER: Conceptual
36. Consider a five-year fixed-payment security that has a present value of $1,500. If the annual rate of discount is 2
percent, the payment made at the end of each year is
a. $231.77.
b. $288.24.
c. $300.00.
d. $310.00.
ANSWER: b
POINTS: 1
OTHER: Conceptual
37. The amount repaid by a coupon bond at maturity is called its value.
a. present
b. future
c. face
d. coupon
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
38. Consider a coupon bond that pays $100 every year and repays its principal amount of $1,000 at the end of 10 years.
If the annual rate of discount is 10 percent, the present value of the bond is approximately
a. $909.09.
b. $990.00.
c. $1,000.00.
d. $1,100.00.
ANSWER: c
POINTS: 1
OTHER: Conceptual
39. Consider a coupon bond that pays $105 every year and repays its principal amount of $1,500 at the end of 3 years. If
the annual rate of discount is 7 percent, the present value of the bond is approximately
a. $735.35.
b. $765.00.
c. $1,395.00.
d. $1,500.00.
ANSWER: d
POINTS: 1
OTHER: Conceptual
40. Consider a three-year coupon bond that has a present value of $2,000. If the annual rate of discount is 7 percent, and
the payment made at the end of each year is $140, the principal amount to be repaid at the end of three years is
a. $1,860.00.
b. $2,000.00.
c. $2,140.00.
d. $2,156.40.
ANSWER: b
POINTS: 1
OTHER: Conceptual
41. Consider a two-year coupon bond that has a present value of $10,000. If the rate of discount is 3 percent, and the
payment made at the end of each year is $300, the principal amount to be repaid at the end of two years is
a. $10,000.00.
b. $10,300.00.
c. $33,333.33.
d. $333,333.33.
ANSWER: a
POINTS: 1
OTHER: Conceptual
42. Consider a coupon bond that pays $100 every year and repays its principal amount of $1,000 at the end of four
years. If the annual rate of discount is 8 percent, the present value of the bond is
a. $671.01.
b. $1,066.24
c. $1,134.20.
d. $1,250.00.
ANSWER: b
POINTS: 1
OTHER: Conceptual
43. Consider a coupon bond that pays $150 every year and repays its principal amount of $1,500 at the end of five years.
If the annual rate of discount is 7 percent, the present value of the bond is approximately
a. $214.29.
b. $808.39.
c. $1,684.50.
d. $1,742.52.
ANSWER: c
POINTS: 1
OTHER: Conceptual
44. Consider a one-year coupon bond that has a present value of $2,000. If the annual rate of discount is 5 percent, and
the payment made at the end of each year is $140, the principal amount to be repaid at the end of one year is
a. $1,234.65.
b. $1,363.32.
c. $1,960.00.
d. $2,000.00.
ANSWER: c
POINTS: 1
DIFFICULTY: Challenging
OTHER: Conceptual
45. Consider a two-year coupon bond that has a present value of $10,000. If the annual rate of discount is 3 percent, and
the payment made at the end of each year is $250, the principal amount to be repaid at the end of two years is
a. $10,101.50.
b. $10,300.00.
c. $13,333.33.
d. $13,583.33.
ANSWER: a
POINTS: 1
OTHER: Conceptual
46. If the annual rate of interest in a market is 12%, the monthly rate of discount will equal
a. 1%.
b. 12%.
c. 24%.
d. 144%.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Using Present Value to Make Decisions
OTHER: Factual
47. Consider the returns on four investment options: A, B, C, and D. All four investment options require the same
principal amount, and the returns on the investments are considered over the same time frame. The present value of
the return on investment A is greater than the present value of the return on investment B, which is greater than the
present value of the return on investment C. The present value of the return on investment D is the lowest. A
rational investor will choose to invest in:
a. option A.
b. option B.
c. option C.
d. option D.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
OTHER: Conceptual
48. According to the theory underlying the present-value formula, would a rational individual prefer to receive (a) $75
one year from now, (b) $85 two years from now, or (c) $90 three years from now, or would he be indifferent
between all three choices? Assume that the relevant annual market interest rate is 10 percent and will remain at 10
percent for the next three years?
a. He will prefer $75 one year from now. b.
He will prefer $85 two years from now. c.
He will prefer $90 three years from now.
d. He will be indifferent between all three choices.
ANSWER: b
POINTS: 1
OTHER: Conceptual
49. According to the theory underlying the present-value formula, would a rational individual prefer to receive (a) $75
one year from now, (b) $85 two years from now, or (c) $90 three years from now, or would he be indifferent
between all three choices? Assume that the relevant annual market interest rate is 20 percent and will remain at 20
percent for the next three years?
a. He will prefer $75 one year from now. b.
He will prefer $85 two years from now. c.
He will prefer $90 three years from now.
d. He will be indifferent between all three choices.
ANSWER: a
POINTS: 1
OTHER: Conceptual
50. Your favorite magazine, Fun with Present Value, offers you four different subscription deals for the next four
years. It has guaranteed its current and future subscription rates, as shown below. Which will you take, if your
annual rate of discount is 6 percent and you want to get the magazine for four years?
a. A one-year subscription for $24, followed by a one-year renewal each year for $24 each year.
b. A two-year subscription for $45, followed by a two-year renewal for $48.
c. A three-year subscription for $72, followed by a one-year renewal for $24.
d. A four-year subscription for $89.
ANSWER: b
POINTS: 1
OTHER: Conceptual
51. A rise in the annual interest rates will cause a.
the principal amount of a bond to increase. b.
the principal amount of a bond to decrease. c.
the present value of a bond to decrease.
d. the present value of a bond to increase.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
52. Suppose you take out a car loan of $10,000 for 3 years at an annual interest rate of 8 percent, with payments to be
made monthly. What will be the approximate monthly payments? The relevant formula is:
a. $313.36.
b. $323.36.
c. $853.45.
d. $3,880.34.
ANSWER: a
POINTS: 1
TOPICS: Using the Present-Value Formula to Calculate Payments
OTHER: Conceptual
53. Suppose you take out a home equity loan of $100,000 for 5 years at an annual interest rate of 5 percent, with
payments to be made monthly. What will the approximate monthly payments be? The relevant formula is:
a. $1,320.71
b. $1,887.12
c. $1,924.79
d. $5,282.82
ANSWER: b
POINTS: 1
OTHER: Conceptual
54. Past return refers to the
a. highest annual return that a security has produced in the past.
b. mode of the annual returns that a security has produced in the past.
c. average of the annual returns that a security has produced in the past.
d. median of the annual returns that a security has produced in the past.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Looking Forward or Looking Backward at Returns
OTHER: Factual
55. You are considering buying a discount bond that costs $1,000 today and pays you $1,200 in one year. However,
there is a 10 percent chance that the company issuing the bond will go bankrupt and not pay you your interest or
return your principal. What is the expected return on the bond?
a. 20 percent.
b. 10 percent.
c. 8 percent.
d. −4 percent.
ANSWER: c
POINTS: 1
OTHER: Conceptual
56. John spends $4,000 on a perpetuity that pays $150 each year. The yield to maturity of this perpetuity is
a. 1.5%.
b. 3.75%.
c. 6.2 %.
d. 15%.
ANSWER: b
POINTS: 1
OTHER: Conceptual
57. According to the Truth-in-Savings Act, the interest rate that banks are required to report when you deposit money in
an account is known as
a. capital-gains yield.
b. annual percentage yield.
c. current yield.
d. total return.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Annual Percentage Yield
OTHER: Factual
58. Consider a one-year discount bond that pays $2,000 one year from now. If the annual rate of discount is 3 percent,
calculate the present value of the bond.
ANSWER: P = $2,000/(1 + .03) = $1,941.75

POINTS: 1
59. Consider a one-year discount bond that has a present value of $3,000. If the annual rate of discount is 5 percent,
calculate the future value of the bond (the amount the bond pays in one year).
ANSWER: F = $3,000 × (1 + .05) = $3,150.00

POINTS: 1
60. Consider a perpetuity that pays $300 every year. If the rate of discount is 6 percent, calculate the present value of
the bond.
ANSWER: P = $300/0.06 = $5,000.

POINTS: 1
61. Consider a fixed-payment security that pays $250 at the end of every year for eight years. If the annual rate of
discount is 3 percent, calculate the present value of the bond.
ANSWER: Use the equation .
With F = $250, i = 0.03, and N = 8, then P = $1,754.92.

POINTS: 1
62. Consider a coupon bond that pays $150 every year and repays its principal amount of $2,000 at the end of six years.
If the annual rate of discount is 7.5 percent, what is the present value of the bond?
ANSWER: Present value = 150 × [1 - (1/1.075)6/.075] + 2000/(1.075)6 = $2,000.

POINTS: 1
63. Consider a coupon bond that pays $350 every year and repays its principal amount of $5,000 at the end of four
years. If the annual rate of discount is 6 percent, what is the present value of the bond?
ANSWER: Use the equation .
With F = $350, i = 0.06, N = 4, and V = $5,000, then P = $5,173.26.

POINTS: 1
64. Answer the questions below.
You are negotiating a book deal for your newest novel in which an economist single-handedly
saves the world. The publisher offers to pay you an advance of $1 million today plus $500,000
a.
at the end of each of the next three years. What is the present value of these payments,
given the annual rate of discount is 5 percent? Show your work.
You counter the publisher's offer with a counteroffer that will pay you $1.5 million today plus
$5 per book sold in each of the next three years. You think you will sell 80,000 books each
b. year in the next three years, but the publisher thinks you will only sell 40,000 books each year.
Explain why both you and the publisher like this counteroffer better than the deal in part a.
Show your work.
ANSWER: a. To simplify calculations, all returns can be converted into thousands.
Hence, the present value of the total return is $2,362,000.

b. If you are right:
Hence, the present value of the total return from this payoff is $2,590,000. You like this better
than the offer in part a, as you get more from the publisher.
If the publisher is right:
Hence, the present value of the total return from this payoff is $2,044,000 The publisher likes
this better than the offer in part a as the publisher pays less to you.
POINTS: 1

65. Answer the questions below.
You buy a government bond that pays interest twice a year. The interest payment is $300
each six months. The bond matures in six years. The face value of the bond is $10,000. The
a.
annual market interest rate is 6 percent. What is the present value of the bond? Show your
work.
A formula that may be useful to you is:
After six months go by, you receive the first interest payment of $300. The annual market
b. interest rate has declined to 5 percent and you decide to sell the bond. What is the bond's
present value when you sell it? Show your work.
What is your total return from owning the bond for six months (expressed at an annual rate,
c.
in percentage points, with two decimals)? Show your work.
ANSWER: a. $10,000; no calculation needed.
If you calculated the present value from the formula, you would need V = $10,000, F = $300, i =
.06/2, and N = 12, so
= 2,986.20 + 7,013.80 = $10,000.
b. Now, V = $10,000, F = $300, i = .05/2, and N = 11, so
= 2,854.26 + 7,621.45 = $10,475.71.
Your total return (at an annual rate) is 15.51 percent, which is derived from your interest of $300 +
c. capital gains of $475.51 = total earnings of $775.51, divided by $10,000 = 7.755 percent, multiplied
by 2 to put it at an annual rate = 15.51 percent.
POINTS: 1

66. You borrow $30,000 for 10 years to pay tuition and fees. The annual interest rate is 12 percent. What monthly
payment would be required to pay off the loan?
ANSWER: Use the following formula:
where P = $30,000; i = 0.12 ÷ 12 = 0.01; N = 10 x 12 = 120
POINTS: 1
67. On September 1, 2012, Al buys a bond for $15,000 that makes coupon payments of $750 after each of the following
three years and returns its principal of $15,000 at the end of the three years. In other words, it is a standard coupon
bond with a 5 percent annual interest rate making payments once each year.
On September 1, 2013, Al receives his first coupon payment of $750. At that time, the market interest rate on bonds
like Al's has risen to 6 percent. Al sells his bond to Biff at that time, for a price equal to the present value of the
bond's payments.
a. How much does Biff pay Al for the bond?
b. Calculate Al's current yield, capital-gains yield, and total return for the year.
On September 1, 2014, Biff receives a coupon payment of $750. The market interest rate on bonds like his remains 6
percent. Biff sells his bond to Cass at that time, for a price equal to the present value of the bond's payments.
c. How much does Cass pay Biff for the bond?
d. Calculate Biff's current yield, capital-gains yield, and total return for the year.
On September 1, 2015, Cass receives a coupon payment of $750 and the principal of $15,000. Over the course of
the year (between September 1, 2014, and September 1, 2015), the market interest rate on bonds like his rose to 7
percent. But Cass decided to keep the bond.
e. What is Cass's total return for the year?

Explain and show all your work for each part.
a.
ANSWER:
b.
Total return = current yield + capital-gains yield = 5% − 1.83% = 3.17%
c.
d.
Total return = current yield + capital-gains yield = 5.09% + 0.91% = 6%
You should expect this because Biff bought the bond at a yield to maturity of 6 percent and held it for
a year, and the market interest rate did not change.
e. Six percent, since Cass bought it when the yield to maturity was 6 percent and held it until it matured.
You could also do this one the hard way:
Total return = current yield + capital-gains yield = 5.05% + 0.95% = 6%

POINTS: 1
68. On February 1, 2013, Janet buys a bond for $10,000 that makes coupon payments of $600 after each of the following
two years and returns its principal of $10,000 at the end of the second year. In other words, it is a standard coupon
bond with a 6 percent annual interest rate making payments once each year.
On February 1, 2014, Janet receives her first coupon payment of $600. At that time, the market interest rate on
bonds like hers has fallen to 4 percent. She sells her bond to Justin at that time, for a price equal to the present value
of the bond's payments.
a. How much does Justin pay Janet for the bond?

Both Janet and Justin have tax rates of 30 percent on interest income and 20 percent on capital gains. (Note that if
someone has a capital loss, you may assume that he or she can reduce taxes by the amount of the capital loss times
the tax rate of 20 percent.)
Calculate Janet's after-tax rate of return for the past year (from Feb. 1, 2013, to Feb. 1,
b.
2014).
Justin holds onto the bond from February 1, 2014, to February 1, 2015, so it matures and he receives the second
coupon payment and the principal.
c. What is Justin's after-tax rate of return for the year from Feb. 1, 2014, to Feb. 1, 2015?
Explain and show all your work for each part. You may assume, of course, that the market works and does not
malfunction.
The bond has one year left to maturity, which pays interest of $600 and repays principal of
a.
ANSWER: $10,000, so the price of the bond is
Her total return consists of current yield plus capital-gain yield. Doing these in after-tax terms
b.
means subtracting off the taxes for each.
Interest payment = $600
Tax on interest payment = $600 × 0.3 = $180
Interest after taxes = $600 − $180 = $420
After-tax current yield = = 0.042 = 4.2%
Capital gains = $10,192.31 − $10,000 = $192.31
Tax on capital gains = $192.31 × 0.2 = $38.46
Capital gains after taxes = $192.31 − $38.46 = $153.85
After-tax capital-gains yield = = 0.015 = 1.5%
Total after-tax return = after-tax current yield + after-tax capital-gains yield

= 4.2% + 1.5%
= 5.7%
Justin gets $600 in interest, so his interest after taxes is the same as Janet's was, which is
c.
$420. But he paid more, so his current yield will be lower:
After-tax current yield = = 0.041 = 4.1%
Justin gets a capital loss because he bought the bond for $10,192.31 and it pays only $10,000
when it matures.
Capital gains = $10,000 − $10,192.31 = −$192.31

Tax on capital gains = −$192.31 × 0.2 = −$38.46
Capital gains after taxes = −$192.31 − (−$38.46) = −$153.85
After-tax capital-gains yield = = −0.015 = −1.5%
Total after-tax return = after-tax current yield + after-tax capital-gains yield

= 4.2% + (−1.5%)
= 2.6%
POINTS: 1

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M and B 3 3rd Edition Dean Croushore

Test Bank: https://testbankpack.com/p/test-bank-for-m-and-b-3-3rd-

Solution Manual: https://testbankpack.com/p/solution-manual-for-m-

6. In the one-period present-value equation, P = F/(1 + i), the term 1 + i is referred to as

9. Which of the following statements is true?

11. The present value of a series of future payments is

22. Which of the following statements is true?

ANSWER: P = $2,000/(1 + .03) = $1,941.75

ANSWER: F = $3,000 × (1 + .05) = $3,150.00

ANSWER: P = $300/0.06 = $5,000.

ANSWER: Use the equation .

With F = $250, i = 0.03, and N = 8, then P = $1,754.92.

ANSWER: Present value = 150 × [1 - (1/1.075)6/.075] + 2000/(1.075)6 = $2,000.

ANSWER: Use the equation .

With F = $350, i = 0.06, N = 4, and V = $5,000, then P = $5,173.26.

ANSWER: a. To simplify calculations, all returns can be converted into thousands.

Hence, the present value of the total return is $2,362,000.

If the publisher is right:

TOPICS: The General Form of the Present-Value Formula

A formula that may be useful to you is:

ANSWER: a. $10,000; no calculation needed.

= 2,986.20 + 7,013.80 = $10,000.

b. Now, V = $10,000, F = $300, i = .05/2, and N = 11, so

= 2,854.26 + 7,621.45 = $10,475.71.

TOPICS: The General Form of the Present-Value Formula

ANSWER: Use the following formula:

where P = $30,000; i = 0.12 ÷ 12 = 0.01; N = 10 x 12 = 120

a. How much does Biff pay Al for the bond?

c. How much does Cass pay Biff for the bond?

e. What is Cass's total return for the year?

Total return = current yield + capital-gains yield = 5% − 1.83% = 3.17%

Total return = current yield + capital-gains yield = 5.09% + 0.91% = 6%

You could also do this one the hard way:

Total return = current yield + capital-gains yield = 5.05% + 0.95% = 6%

TOPICS: Looking Forward or Looking Backward at Returns

a. How much does Justin pay Janet for the bond?

Interest payment = $600

Tax on interest payment = $600 × 0.3 = $180

Interest after taxes = $600 − $180 = $420

After-tax current yield = = 0.042 = 4.2%

Capital gains = $10,192.31 − $10,000 = $192.31

Tax on capital gains = $192.31 × 0.2 = $38.46

Capital gains after taxes = $192.31 − $38.46 = $153.85

After-tax capital-gains yield = = 0.015 = 1.5%

Total after-tax return = after-tax current yield + after-tax capital-gains yield

After-tax current yield = = 0.041 = 4.1%

Capital gains = $10,000 − $10,192.31 = −$192.31

Capital gains after taxes = −$192.31 − (−$38.46) = −$153.85

After-tax capital-gains yield = = −0.015 = −1.5%

Total after-tax return = after-tax current yield + after-tax capital-gains yield

TOPICS: Looking Forward or Looking Backward at Returns

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