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Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)

Chapter 5 Interest Rates

5.1 Interest Rate Quotes and Adjustments

1) When you borrow money, the interest rate on the borrowed money is the price you pay to

be able to convert your future loan payments into money today.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: DS

Question Status: Previous Edition

2) When there are large numbers of people looking to save their money and there is little

demand for loans, one would expect interest rates to be high.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: DS

Question Status: Previous Edition

3) The annual percentage rate indicates the amount of interest, including the efect of any

compounding.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: DS

Question Status: Previous Edition

4) Which of the following would be LEAST likely to lower the interest rate that a bank

ofers a borrower?

A) The number of borrowers seeking funds is low.

B) The expected inlation rate is expected to be low.

C) The borrower is judged to have a low degree of risk.

D) The loan will be for a long period of time.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: DS

Question Status: Revised

5) What is the efective annual rate (EAR)?

A) It is the interest rate that would earn the same interest with annual compounding.

B) It is the ratio of the number of the annual percentage rate to the number of

compounding periods per year.

C) It is the interest rate for an n-year time interval, where n may be more than one year or

less than or equal to one year (a fraction).

D) It refers to the cash lows from an investment over a one-year period divided by the

number of times that interest is compounded during the year.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

6) A bank ofers a loan that will requires you to pay 7% interest compounded monthly.

Which of the following is closest to the EAR charged by the bank?

A) 5.78%

B) 8.68%

C) 7.23%

D) 14.46%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

7) A bank pays interest semiannually with an EAR of 13%. What is the periodic interest rate

applicable semiannually?

A) 5.04%

B) 7.56%

C) 6.30%

D) 12.60%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

8) Howard is saving for a holiday. He deposits a ixed amount every month in a bank

account with an EAR of 14.7%. If this account pays interest every month then how much

should he save from each monthly paycheck in order to have $14,000 in the account in four

years’ time?

A) $176

B) $308

C) $220

D) $352

AACSB Objective: Relective Thinking Skills

Author: DS

Question Status: Revised

9) A(n) 12% APR with monthly compounding is closest to ________.

A) an EAR of 10.14%

B) an EAR of 15.22%

C) an EAR of 12.68%

D) an EAR of 25.36%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

10) Which of the following best describes the annual percentage rate?

A) the quoted interest rate which, considered with the compounding period, gives the

efective interest rate

B) the efective annual rate, after compounding is taken into account

C) the discount rate, when compounded more than once a year or less than once a year

D) the discount rate, when efective annual rate is divided by the number of times it is

compounded in a year

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

11) An animator needs a laptop for audio/video editing, and notices that he can pay $2600

for a Dell XPS laptop, or lease from the manufacturer for monthly payments of $75 each for

four years. The designer can borrow at an interest rate of 14% APR compounded monthly.

What is the cost of leasing the laptop over buying it outright?

A) Leasing costs $116 more than buying.

B) Leasing costs $174 more than buying.

C) Leasing costs $145 more than buying.

D) Leasing costs $289 more than buying.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

12) Which of the following accounts has the highest EAR?

A) one that pays 5.4% every six months

B) one that pays 1.0% per month

C) one that pays 9.6% per year

D) one that pays 2.4% every three months

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

13) Drew receives an inheritance that pays him $54,000 every three months for the next

two years. Which of the following is closest to the present value (PV) of this inheritance if

the interest rate is 8.9% (EAR)?

A) $314,366

B) $471,549

C) $392,957

D) $432,000

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

14) The table above shows the rate of return (APR) for four investment alternatives. Which

ofers the highest EAR?

Investment: A B C D

Rate of

Return: 6.0% 5.9% 5.8% 5.7%

Compoundin

gYearly Semiannually Monthly Weekly

A) Investment A

B) Investment B

C) Investment C

D) Investment D

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

15) A bank ofers an account with an APR of 5.8% and an EAR of 5.88%. How does the bank

compound interest for this account?

A) weekly compounding

B) monthly compounding

C) semiannual compounding

D) annual compounding

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

16) Which of the following statements is FALSE about interest rates?

A) As interest rates may be quoted for diferent time intervals, it is often necessary to

adjust the interest rate to a time period that matches that of cash lows.

B) The efective annual rate indicates the amount of interest that will be earned at the end

of one year.

C) The annual percentage rate indicates the amount of simple interest earned in one year.

D) The annual percentage rate indicates the amount of interest including the efect of

compounding.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: JN

Question Status: Revised

17) The efective annual rate (EAR) for a loan with a stated APR of 8% compounded

monthly is closest to ________.

A) 8.30%

B) 9.13%

C) 9.96%

D) 10.79%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

18) The efective annual rate (EAR) for a loan with a stated APR of 11% compounded

quarterly is closest to ________.

A) 12.61%

B) 13.75%

C) 11.46%

D) 14.90%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

19) The efective annual rate (EAR) for a savings account with a stated APR of 5%

compounded daily is closest to ________.

A) 5.64%

B) 6.15%

C) 5.13%

D) 6.66%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

20) Consider the following investment alternatives:

Investment APR

Compoundin

A 6.2200% Annual

B 6.0583% Daily

C 6.1277% Quarterly

D 6.1204% Monthly

Which alternative ofers you the highest efective rate of return?

A) Investment A

B) Investment B

C) Investment C

D) Investment D

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

21) Consider the following investment alternatives:

Investment APR

Compoundin

A 6.9030% Annual

B 6.6992% Daily

C 6.7787% Quarterly

D 6.7643% Monthly

Which alternative ofers you the lowest efective rate of return?

A) Investment A

B) Investment B

C) Investment C

D) Investment D

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

22) Consider the following investment alternatives:

Investment APR Compoundin

A 6.0860% Annual

B 5.9320% Daily

C 5.9997% Quarterly

D 5.9936% Monthly

The highest efective rate of return you could earn on any of these investments is closest to

________.

A) 6.0860%

B) 6.1110%

C) 6.1610%

D) 6.1360%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

23) Consider the following investment alternatives:

Investment APR

Compoundin

A 6.3830% Annual

B 6.2116% Daily

C 6.2834% Quarterly

D 6.2744% Monthly

The lowest efective rate of return you could earn on any of these investments is closest to

________.

A) 6.3830%

B) 6.4080%

C) 6.4330%

D) 6.4580%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

24) Your irm needs to invest in a new delivery truck. The life expectancy of the delivery

truck is ive years. You can purchase a new delivery truck for an upfront cost of $350,000,

or you can lease a truck from the manufacturer for ive years for a monthly lease payment

of $7000 (paid at the end of each month). Your irm can borrow at 9.00% APR with

quarterly compounding.

The efective annual rate on your irm’s borrowings is closest to ________.

A) 9.00%

B) 7.45%

C) 11.17%

D) 9.31%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

25) Your irm needs to invest in a new delivery truck. The life expectancy of the delivery

truck is ive years. You can purchase a new delivery truck for an upfront cost of $300,000,

or you can lease a truck from the manufacturer for ive years for a monthly lease payment

of $6000 (paid at the end of each month). Your irm can borrow at 8.00% APR with

quarterly compounding.

The monthly discount rate that you should use to evaluate the truck lease is closest to

________.

A) 0.5298%

B) 0.7947%

C) 0.6623%

D) 0.6667%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

26) A 10% APR with quarterly compounding is equivalent to an EAR of ________.

A) 10.00%

B) 10.47%

C) 10.38%

D) 9.81%

AACSB Objective: Analytic Skills

Author: WC

Question Status: New

27) A 12% APR with bi-monthly compounding is equivalent to an EAR of ________.

A) 11.98%

B) 12.50%

C) 12.00%

D) 12.62%

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: WC

Question Status: New

28) Which of the following is/are TRUE?

I. The EAR can never exceed the APR.

II. The APR can never exceed the EAR.

III. The APR and EAR can never be equal.

A) Only I. is true.

B) Only II. is true.

C) Only II. & III. are true.

D) Only I. & III. are true.

AACSB Objective: Analytic Skills

Author: WC

Question Status: New