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23) Suppose the term structure of interest rates is shown below:
Term 1 year 2 years 3 years 5 years 10 years 20 years
Rate
(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%
The present value (PV) of receiving $1100 per year with certainty at the end of the next
three years is closest to ________.
A) $3010
B) $2408
C) $3612
D) $4214
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
24) Suppose the term structure of interest rates is shown below:
Term 1 year 2 years 3 years 5 years 10 years 20 years
Rate
(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%
Consider an investment that pays $1900 certain at the end of each of the next four years. If
the investment costs $6650 and has a net present value (NPV) of $142.31, then the four
year risk-free interest rate is closest to ________.
A) 4.01%
B) 3.51%
C) 5.01%
D) 4.51%
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
38
25) Suppose the term structure of interest rates is shown below:
Term 1 year 2 years 3 years 5 years 10 years 20 years
Rate
(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%
The net present value (NPV) of an investment that costs $4320 and pays $1600 certain at
the end of one, three, and ive years is closest to ________.
A) $91.37
B) $137.05
C) $114.21
D) -$114.21
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
26) In 2009, U.S. Treasury yielded 0.1%, while inlation was 2.7%. What was the real rate in
2009?
A) -2.6%
B) 2.6%
C) -2.8%
D) 2.8%
AACSB Objective: Analytic Skills
Author: WC
Question Status: New
27) Inlation is calculated as the rate of change in the _______.
A) unemployment rate
B) Gross Domestic Product
C) Consumer Price Index
D) risk-free rate
AACSB Objective: Analytic Skills
Author: WC
Question Status: New
39
28) The yield curve is typically ________.
A) downward sloping
B) upward sloping
C) lat
D) inverted
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
29) Can the nominal interest rate ever be negative? Can the real interest rate ever be
negative? Explain.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
Use the table for the question(s) below.
Suppose the term structure of interest rates is shown below:
Term 1 year 2 years 3 years 5 years 10 years 20 years
Rate (EAR
%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%
30) After examining the yield curve, what predictions do you have about interest rates in
the future? About future economic growth and the overall state of the economy?
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: JN
Question Status: Revised
40
31) What is the net present value (NPV) of an investment that costs $2,500 and pays
$1,000 at the end of one, three, and ive years?
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
32) What is the implied assumption about interest rates when using the built-in functions of
a inancial calculator to calculate the present value (PV) of an annuity?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
33) What is the implied assumption about interest rates when the equation to calculate the
present value (PV) of perpetuity is used?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
5.4 The Opportunity Cost of Capital
1) The opportunity cost of capital is the best available expected return ofered in the
market on an investment of comparable risk and term to the cash low being discounted.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) The term "opportunity" in opportunity cost of capital comes from the fact that any
worthwhile opportunity for investment will have a cost: the risk to the capital invested.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) For a free-risk investment, the opportunity cost of capital will generally be more than the
interest rate ofered by U.S. Treasury securities with a similar term.
AACSB Objective: Analytic Skills
41
Author: DS
Question Status: Revised
4) What, typically, is used to calculate the opportunity cost of capital on a risk-free
investment?
A) the best expected return ofered in any investment available in the market
B) the interest rate on U.S. Treasury securities with the same term
C) the interest rate of any investments alternatives that are available
D) the best rate of return ofered by U.S. Treasury securities
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) Elinore is asked to invest $5100 in a friend's business with the promise that the friend
will repay $5610 in one year. Elinore inds her best alternative to this investment, with
similar risk, is one that will pay her $5508 in one year. U.S. securities of similar term ofer a
rate of return of 7%. What is the opportunity cost of capital in this case?
A) 7%
B) 8%
C) 9%
D) 10%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
42
6) Why, in general, do investment opportunities ofer a rate greater than that ofered by
U.S. Treasury securities for the same horizon?
A) Most investment opportunities bear far greater risk than those ofered by U.S. Treasury
securities.
B) The return from U.S. Treasury securities generally attracts less tax than the returns
from other investments.
C) The opportunity cost of capital for a given horizon is generally based on U.S. Treasury
securities with that same horizon.
D) U.S. Treasury securities are generally considered to be the best alternative to most
investments.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) Which of the following statements is FALSE?
A) The opportunity cost of capital is the best available expected return ofered in the
market on an investment of comparable risk and term of the cash lows being discounted.
B) Interest rates we observe in the market will vary based on quoting conventions, the term
of investment, and risk.
C) The opportunity cost of capital is the return the investor forgoes when the investor takes
on a new investment.
D) For a risk-free project, the opportunity cost of capital will typically be greater than the
interest rate of U.S. Treasury securities with a similar term.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
8) Which of the following statements is FALSE?
A) The actual return kept by an investor will depend on how the interest is taxed.
B) The equivalent after-tax interest rate is r(1 - τ).
C) The highest interest rate for a given horizon is the rate paid on U.S. Treasury securities.
D) It is important to use a discount rate that matches both the horizon and the risk of the
cash lows.
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: JN
Question Status: Previous Edition
43
9) How do we decide on opportunity cost when we have several opportunities that need to
be foregone?
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: SS
Question Status: Previous Edition
44
