Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 1
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in
multiple-choice questions.
Multiple Choice: True/False
1. Starting to invest early for retirement increases the benefits of compound interest.
a. True
b. False
2. Starting to invest early for retirement reduces the benefits of compound interest.
a. True
b. False
3. A time line is meaningful even if all cash flows do not occur annually.
a. True
b. False
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 4
b. False
10. Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts.
a. True
b. False
11. If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the
future value of the same series.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero.
Page 5
12. If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the
present value of the same series.
a. True
b. False
13. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future
value.
a. True
b. False
14. Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present
value.
a. True
b. False
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 9
a. True
b. False
23. All other things held constant, the present value of a given annual annuity decreases as the number of periods per year
increases.
a. True
b. False
24. All other things held constant, the present value of a given annual annuity increases as the number of periods per year
increases.
a. True
b. False
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 11
28. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the
nominal rate on the deposit (or loan).
a. True
b. False
29. When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the
early years, and the principal repayment’s percentage declines in the loan’s later years.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero.
Page 12
30. When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the
early years, and the principal repayment’s percentage increases in the loan’s later years.
a. True
b. False
31. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal.
The closer we are to the end of the loan’s life, the greater the percentage of the payment that will be a repayment of
principal.
a. True
b. False
32. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal.
The closer we are to the end of the loan’s life, the smaller the percentage of the payment that will be a repayment of
principal.
a. True
b. False
Chapter 05: Time Value of Money
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 17
40. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected
cash flows. Which of the following would increase the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts
for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.
b. The discount rate decreases.
c. The riskiness of the investment’s cash flows increases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and
less are received in the earlier years.
e. The discount rate increases.
41. Which of the following statements is CORRECT?
a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an
annuity.
c. The cash flows for an annuity due must all occur at the ends of the periods.
d. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or
once a month.
e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the
textbook defines as a variable annuity.
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 18
42. Which of the following statements is CORRECT?
a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an
annuity.
c. The cash flows for an annuity due must all occur at the beginning of the periods.
d. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as
once a year or once a month.
e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the
textbook defines as a variable annuity.
43. Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following
statements is CORRECT?
a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%.
b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%.
c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.
d. The periodic rate of interest is 3% and the effective rate of interest is 6%.
e. The periodic rate of interest is 6% and the effective rate of interest is also 6%.
44. Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following
statements is CORRECT?
a. The periodic rate of interest is 2% and the effective rate of interest is 4%.
b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 19
c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%.
d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.
e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.
45. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is
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 7 years, and if the interest rate were the same in either case,
the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if
the interest rate were lower.
d. The last payment would have a higher proportion of interest than the first payment.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
46. A $150,000 loan is to be amortized over 7 years, with annual end–of-year payments. Which of these statements is
CORRECT?
a. The annual payments would be larger if the interest rate were lower.
Chapter 05: Time Value of Money
Copyright Cengage Learning. Powered by Cognero.
Page 20
b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case,
the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if
the interest rate were lower.
d. The proportion of each payment that represents interest versus repayment of principal would be higher if the
interest rate were higher.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
47. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT?
(Ignore taxes and transactions costs.)
a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three
years.
b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal
payments) are constant.
c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will
remain constant.
d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now
than it will be the first year.
e. The outstanding balance declines at a slower rate in the later years of the loan’s life.