978-0134730417 Test Bank Chapter 5 Part 1

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Financial Management: Core Concepts, 4e (Brooks)

Chapter 5 Interest Rates

1) If you take out a loan from a bank, you will be charged ________.

A) for principal but not interest

B) for interest but not principal

C) for both principal and interest

D) for interest only

2) A company selling a bond is ________ money.

A) borrowing

B) lending

C) taking

D) reinvesting

3) The phrase “price to rent money” is sometimes used to refer to ________.

A) historical prices

B) compound rates

C) discount rates

D) interest rates

4) Suppose you deposit money in a certificate of deposit (CD) at a bank. Which of the following

statements is TRUE?

A) The bank is borrowing money from you without a promise to repay that money with interest.

B) The bank is lending money to you with a promise to repay that money with interest.

C) The bank is technically renting money from you with a promise to repay that money with

interest.

D) The bank is lending money to you, but not borrowing money from you.

5) Which of the following statements is FALSE?

A) The APR can be referred to as a promised annual percentage rate.

B) Although an APR is quoted on an annual basis, interest can be paid quarterly.

C) The period in which interest is applied or the frequency of times interest is added to an

account each year is called the compounding period or compounding periods per year.

D) Although an APR is quoted on an annual basis, interest can be paid monthly but never daily.

6) To determine the interest paid each compounding period, we take the advertised annual

percentage rate and simply divide it by the ________ to get the appropriate periodic interest rate.

A) number of compounding periods for the length of an investment

B) number of discounting periods for the length of an investment

C) number of compounding periods per year

D) number of compounding periods per month

7) Suppose you invest $1,000 today, compounded quarterly, with the annual interest rate of

8.00%. What is your investment worth in one year?

A) $1,080.00

B) $1,800.00

C) $1,082.43

D) $1,824.30

8) Rodney invests $2,400 today, compounded monthly, with an annual interest rate of 6.25%.

What is Rodney’s investment worth in one year?

A) $2,554.37

B) $2,532.00

C) $2,515.66

D) $2,503.57

9) What if Jennifer were to invest $2,750 today, compounded semiannually, with an annual

interest rate of 5.25%. What amount of interest will Jennifer earn in one year?

A) $2,896.27

B) $84.27

C) $525.27

D) $146.27

10) Kenna invests $5,000 today, compounded monthly, with an annual interest rate of 8.52%.

What amount of interest will she earn in one year?

A) $334.04

B) $5,443.04

C) $443.04

D) $5,334.04

11) What is the EAR if the APR is 5% and compounding is quarterly?

A) Slightly above 5.09%

B) Slightly below 5.09%

C) Under 5.00%

D) Over 5.25%

12) What is the EAR if the APR is 10.52% and compounding is daily?

A) Slightly above 10.09%

B) Slightly below 11.09%

C) Slightly above 11.09%

D) Over 11.25%

13) The EAR is 5.85% if the APR is 5.85% and compounding is annual.

14) The EAR is about 6.09% if the APR is 6.01% and compounding is monthly.

15) The “Truth in Savings Law” requires banks to advertise their rates on investments such as

CDs and savings accounts as annual percentage yields (APY).

16) When quoting rates on loans, the “Truth in Lending Law” requires the bank to state the rate

as an APR, effectively understating the true cost of the loan when interest is computed more

often than once a year.

17) You invest $15,000 at an annual rate of 8.25% for one year. What is the difference in interest

earned if your investment is compounded on a monthly basis instead of an annual basis?

18) You invest $25,000 at an annual rate of 7.25% for one year. What is the difference in interest

earned if you compound this money on a daily basis instead of an annual basis?

5.2 Effect of Compounding Periods on the Time Value of Money Equations

1) Assume that Ray is 38 years old and has 27 years for saving until he retires. He expects an

APR of 7.5% on his investments. How much does he need to save if he puts money away

annually in equal end-of-the-year amounts to achieve a future value of $1,200,000 dollars in 27

years’ time?

A) $44,444.44

B) $20,670.97

C) $14,882.44

D) $13,844.13

2) When interest rates are stated or given for loan repayments, it is assumed that they are

________ unless specifically stated otherwise.

A) daily rates

B) annual percentage rates

C) effective annual rates

D) APYs

3) APRs must be converted to the appropriate periodic rates when compounding is ________.

A) more frequent than once a year

B) less frequent than once a year

C) more frequent than once a month

D) less frequent than once every six months

4) Which of the following statements is TRUE?

A) On many calculators the TVM key for interest is I/Y; this is Interest per Year, or the EAR

rate.

B) On many calculators the TVM key for interest is Y/I; this is Interest per Year, or the APR

rate.

C) On many calculators the TVM key for interest is I/Y; this is Interest per Year, or the APR

rate.

D) On many calculators the TVM key for a period is I/Y.

5) Which of the following statements is TRUE?

A) By DECREASING the number of payments per year, you REDUCE your total cash outflow

but INCREASE your effective borrowing rate.

B) By INCREASING the number of payments per year, you BOOST your total cash outflow but

INCREASE your effective borrowing rate.

C) By INCREASING the number of payments per year, you REDUCE your total cash outflow

but INCREASE your effective borrowing rate.

D) By INCREASING the number of payments per year, you REDUCE your total cash outflow

but DECREASE your effective borrowing rate.

6) As applied to mortgage loans, which of the following statements is FALSE?

A) Advertised rates are annual percentage rates.

B) A spreadsheet uses the periodic interest rate, not the annual percentage rate.

C) By increasing the number of payments per year you increase your effective borrowing rate.

D) You can find a monthly payment by dividing the annual payment by 12.

7) You put 20% down on a home with a purchase price of $250,000. The down payment is thus

$50,000, leaving a balance owed of $200,000. The bank will loan the remaining balance at

3.91% APR. You will make annual payments with a 30-year payment schedule. What is the

annual annuity payment under this schedule?

A) $18,100.23

B) $11,439.96

C) $6,666.67

D) $11,009.49

8) You put 20% down on a home with a purchase price of $250,000. The down payment is thus

$50,000, leaving a balance owed of $200,000. A bank will loan you this remaining balance at

3.91% APR. You will make monthly end-of-the-period payments with a 30-year payment

schedule. What is the monthly annuity payment under this schedule?

A) $944.48

B) $830.53

C) $941.41

D) $5,250.18

9) As applied to mortgage loans, which of the following statements is FALSE?

A) Advertised rates are EARs.

B) A spreadsheet uses the periodic interest rate, not the annual percentage rate.

C) It is essential to know the compounding periods per year in order to use the TVM equations or

determine the actual cost to rent money.

D) A mortgage problem is an annuity problem.

10) When interest rates are stated or given for loan repayments, it is not assumed that they are

annual percentage rates (APRs) unless specifically stated otherwise.

11) An annual percentage rate must be converted to the appropriate periodic rate when

compounding is more frequent than once a year.

12) TVM formulas provide answers for periodic rates (e.g., annual, quarterly, monthly, daily,

etc.) and the total number of periods over the length of the loan.

13) You pay 20% down on a home with a purchase price of $150,000. The bank will loan you

the remaining balance at 6.84% APR. You have an option to make annual payments with a 20-

year payment schedule. What is the annuity payment under the annual plan? Is this a better deal

than an option to make a monthly plan of payments? Explain in terms of the effective cost of

borrowing.

14) You pay 20% down on a home with a purchase price of $300,000. Your bank will loan the

remaining balance of $240,000 at 8% APR with a 30-year maturity. You will make monthly

payments on the loan. What is the monthly annuity payment?

15) You pay 20% down on a home with a purchase price of $180,000. Your bank will loan the

remaining balance of $144,000 at 7% APR. You have an option to make annual payments or

monthly payments on the loan. Both options have a 30-year payment schedule. What is the

annuity payment under the annual plan? What is the annuity payment under the monthly plan?

16) You pay 10% down on a home with a purchase price of $280,000. Your bank will loan the

remaining balance of $252,000 at 8.23% APR. You have an option to make annual payments or

monthly payments on the loan. Both options have a 30-year payment schedule. What are the

annuity payments under the annual plan? What are the annuity payments under the monthly

plan? In terms of the total cash outflows and the effective cost of borrowing, briefly compare

both plans.

1) The number of periods for a consumer loan (n) is equal to the ________.

A) number of years times compounding periods per year

B) number of years

C) number of years in a period

D) number of compounding periods

2) The typical payments on a consumer loan are made at ________.

A) the end of each day

B) the end of each week

C) the end of each month

D) the beginning of each month

3) Monthly interest on a loan is equal to ________.

A) the beginning balance times the APR

B) the ending balance times the annual percentage rate

C) the ending balance times the periodic interest rate

D) the beginning balance times the periodic interest rate

4) Which of the statements below is FALSE?

A) Reducing principal at a faster pace reduces the overall interest paid on a loan.

B) The more frequent the payment, the lower the total interest expense over the life of the loan,

even though the effective rate of the loan is higher.

C) Reducing principal at a faster pace increases the overall interest paid on a loan.

D) Monthly interest on a loan is equal to the beginning balance times the periodic interest rate.

5) Which of the following statements is TRUE if you increase your monthly payment above the

required loan payment?

A) The extra portion of the payment does not go to the principal.

B) You can significantly increase the number of payments needed to pay off the loan.

C) The extra portion of the payment increases the principal.

D) You can significantly reduce the number of payments needed to pay off the loan.

6) Which of the following statements is FALSE if you increase your monthly payment above the

required loan payment?

A) The extra portion of the payment goes to the principal.

B) You can significantly decrease the number of payments needed to pay off the loan.

C) The extra portion of the payment increases the principal.

D) Besides lowering the principal, you can significantly reduce the number of payments needed

to pay off the loan.

7) Suppose that over the life of the loan, the total interest expense for a monthly loan is $7,000,

while the total interest payment for an annual loan is $8,000. Which of the below statements is

FALSE?

A) The difference reflects the reduction of the principal each month versus the annual reduction

of the principal.

B) The more frequent the payment, the lower the total interest expense over the life of the loan,

even though the effective rate of the loan is higher.

C) Reducing principal at a faster pace reduces the overall interest paid on a loan.

D) The more frequent the payment, the lower the total interest expense over the life of the loan,

even though the effective rate of the loan is lower.

8) Suppose that over the life of the loan, the total interest expense for a monthly loan is $17,000,

while the total interest payment for an annual loan is $19,000. Which of the below statements is

FALSE?

A) The difference reflects the reduction of the principal each month versus the annual reduction

of the principal.

B) The more frequent the payment, the lower the total interest expense over the life of the loan,

even though the effective rate of the loan is higher.

C) Reducing principal at a slower pace reduces the overall interest paid on a loan.

D) Reducing principal at a slower pace increases the overall interest paid on a loan.

9) Assume you just bought a new car and now have a car loan to repay. The amount of the

principal is $22,000, the loan is at 5.9% APR, and the monthly payments are spread out over 6

years. What is the loan payment? Use a calculator to determine your answer.

A) $305.56

B) $363.57

C) $331.14

D) $297.70

10) Assume you just bought a new boat and now have a boat loan to repay. The amount of the

principal is $68,000, the loan is at 6.75% APR, and the monthly payments are spread out over 7

years. What is the loan payment? Use a calculator to determine your answer.

A) $1,225.36

B) $1,206.58

C) $809.52

D) $1,081.01

11) You just entered into a $150,000 30-year home mortgage at an annual interest rate of 4.25%

making monthly payments of $737.91. Suppose you add an additional payment of $295.97 each

month to the $737.91 house payment making your total monthly payments equal to $1,033.88.

This extra amount is applied against the principal of the original loan. How long will it take you

to pay off your loan of $150,000? Use a calculator to determine your answer.

A) It will take about 186 months.

B) It will take about 206 months.

C) It will take about 216 months.

D) It will take about 265 months.

12) You just bought a car and took out a loan for $30,000 and are scheduled to make monthly

payments for 6 years at an annual rate of 3.9% APR. Suppose you add $132.01 each month to

the contracted monthly car payment. This extra amount is applied to the principal. How long will

it take you to pay off your loan of $30,000? Use a calculator to determine your answer.

A) It will take just over 54 months.

B) It will take just over 45 months.

C) It will take just over 38 months.

D) It will take just over 30 months.

13) Most consumer loans payments are monthly.

14) An abbreviated amortization schedule illustrates that each month more and more of the

payment is applied to interest and more and more of the payment is applied to the principal.

15) If you read the fine print on a car loan that claims zero percent, you will probably find that it

is for a period much shorter than the full loan period.