54) On Commodity Exchange A it is possible to buy and sell crude oil at $117 per barrel, while on Commodity
Exchange B crude oil can be bought and sold at $118 per barrel. If there are transaction costs of 1% when
buying or selling on either exchange, what is the net effect of buying a barrel of oil on Exchange A and
selling it on Exchange B?
A) –$1.35
B) –$0.17
C) $0.99
D) $1.01
55) Which of the following statements regarding arbitrage and security prices is INCORRECT?
A) We call the price of a security in a normal market the no–arbitrage price for the security.
B) In financial markets it is possible to sell a security you do not own by doing a short sale.
C) When a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the
proceeds.
D) The general formula for the no–arbitrage price of a security is Price(security) = PV(all cash flows paid by
the security).
56) You see on Craigslist that a used XBOX 360 sells for $100 and a new XBOX 360 sells for $300. Is this an
arbitrage opportunity?
A) No., because the market fora used XBOX 360 is not the same as the market for a new XBOX 360.
B) No, because the market for a used XBOX 360 is a competitive market.
C) Yes, because the market for a used XBOX 360 is a competitive market.
D) Yes, because the market for a used XBOX 360 is not the same as the market for a new XBOX 360.
57) Diwali Airlines has a contract that gives them the opportunity to purchase up to 10,000,000 gallons of jet fuel
at $2.00 per gallon. The current market price of jet fuel is $2.26 per gallon. Divali believes they will only
need 6,000,000 gallons of jet fuel. What is the value of this opportunity?
A) $1,560,000
B) $2,600,000
C) $1,040,000
D) $9,040,000
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
58) How does arbitrage help the Law of One Price?
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
59) You are watching TV late one night and see an ad from Ronco for the Dial–o–matic food slicer. You learn
that the Dial–o–matic sells for $29.95. But wait, there’s more! Ronco is also including in this deal a set of
Ginsu steak knives worth $10.95 and another free gift worth $7.95. Assuming that there is a competitive
market for Ronco items, at what price must Ronco be selling this three item Dial–o–matic deal to insure the
absence of an arbitrage opportunity and uphold the Law of One Price?
60) Advanced Micro Devices (NYSE: AMD) is currently trading at $20.75 on the NYSE. Advanced Micro
Devices is also listed on NASDAQ and assume it is currently trading on NASDAQ at $20.50. Does an
arbitrage opportunity exist and, if so, how would you exploit it and how much would you make on a block
trade of 1000 shares?
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
61) What is one of the prerequisite conditions for the Valuation Principle to work?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
62) Dollar amounts received at different points in time cannot be compared in absolute terms.
63) The one–year discount factor is the discount at which we can purchase money in the future.
64) In order to distinguish between inflows and outflows, different colors are assigned to each of these cash
flows when constructing a timeline.
65) A lender lends $10,000, which is to be repaid in annual payments of $2,000 for 6 years. Which of the
following shows the timeline of the loan from the lender’s perspective?
A)
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
–$10,000
$2000
$2000
$2000
$2000
$2000
B)
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
0
$2000
$2000
$2000
$2000
$2000
C)
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
–$10,000
$2000
$2000
$2000
$2000
$2000
$2000
D)
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
–$10,000
$2000
$4000
$6000
$8000
$10,000
$12,000
66) A tenant wants to lease a building for $48,000 per year. She signs a five–year rental agreement that states that
she will pay $24,000 every six months for the next five years. Which of the following is the timeline for her
rental payments, assuming she makes the first payment immediately?
A)
Date
(years)
0
1
2
3
4
5
Cash Flows
(thousands)
–$48
–$48
–$48
–$48
–$48
–$48
B)
Date
(years)
0
1
2
3
4
5
Cash Flows
(thousands)
$48
$48
$48
$48
$48
$48
C)
Date
(years)
0
1
2
3
4
5
6
3 1/2
4
4 1/2
5
Cash Flows
(thousands)
$24
$24
$24
$24
$24
$24
$24
$24
$24
$24
$24
D)
Date
(years)
0
1/2
1
1 1/2
2
2 1/2
3
3 1/2
4
4 1/2
5
Cash Flows
(thousands)
–$24
–$24
–$24
–$24
–$24
–$24
–$24
–$24
–$24
–$24
0
67) Samantha enters a rent–to–own agreement for living room furniture. She will pay $60 per month for one year.
Which of the following shows the timeline for her payments if the first payment is one month from now?
A)
Date
(Months)
1
2
3
4
5
6
7
8
9
10
11
12
Cash
Flows
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
B)
Date
(Months)
0
1
2
3
4
5
6
7
8
9
10
11
12
Cash Flows
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
C)
Date
(Months)
0
1
2
3
4
5
6
7
8
9
10
11
12
Cash Flows
0
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
–$60
D)
Date
(Months)
0
1
2
3
4
5
6
7
8
9
10
11
12
Cash
Flows
–$60
–$120
–$180
–$240
–$300
–$360
–$480
–$540
–$600
–$660
–$720
–$780
–$840
68) The timeline shown below best describes the cash flow of which of the following people?
Date
(years)
0
1
2
3
4
Cash
Flows
–$3500
$1000
$1000
$1000
$1000
A) Joe, who puts down $3500 to buy a car, and then makes annual payments of $1000
B) Harry, who borrows $3500, and then receives an annual payment of $1000
C) Karen, who loans a friend $3500, which friend then pays back the loan in four annual installments of
$1000
D) Leo, who borrows $3500, and then pays back the loan in four annual payments of $1000
69) The timeline shown below best describes which of the following situations?
Date
(Months)
0
1
2
3
4
5
Cash
Flows
–$250
–$250
–$250
–$250
–$250
–$250
A) You make payments of $250 per month for six months.
B) You receive payments of $250 per month for six months.
C) You make payments of $250 per month for five months.
D) You receive payments of $250 per month for five months.
70) Why should you approach every problem by drawing a timeline?
A) Timelines allow you to quickly sum cash flows over time.
B) Timelines eliminate the majority of flawed financial decisions.
C) Timelines can be used to schedule events which are yet to occur.
D) Timelines identify events in a transaction or investment which might otherwise be easily overlooked.
71) Which of the following statements is INCORRECT?
A) In general, money toady is worth more than money in one year.
B)
We define the risk–free interest rate (rf) for a given period as the interest rate at which money can be
borrowed or lent without risk over that period.
C)
We refer to (1 – rf) as the interest rate factor for risk–free cash flows.
D) For most financial decisions, costs and benefits occur at different points in time.
72) If the risk–free rate of interest (rf) is 6%, then you should be indifferent between receiving $250 in one year or
A) $235.85 today.
B) $250.00 today.
C) $265.00 today.
D) none of the above
73) If the risk–free rate of interest (rf) is 6%, then you should be indifferent between receiving $250 today or
A) $235.85 in one year.
B) $250.00 in one year.
C) $265.00 in one year.
D) none of the above
74) Why is it usually necessary to use the time value of money when performing a cost benefit analysis?
A) For an investment project to be considered, costs must have a higher dollar value from benefits.
B) In most investment projects costs are incurred up front, but benefits are provided in the future.
C) For practical purposes, a dollar today may be considered to be equal to a dollar at some future time.
D) Although costs and benefits generally occur concurrently, the benefits will accrue value over time, due
to interest.
75) An investor has the opportunity to buy a $10,000 government bond which is guaranteed to yield 6.5%
interest in one year’s time. The investor decides to make the investment as there is a net difference between
the cost and benefit. Which of the following is NOT a reason that the investor’s decision may be flawed?
A) It does not consider the current market interest rate.
B) It ignores the fact that the costs are incurred today, but the benefits occur in one year’s time.
C) It does not consider the value of the $10,000 in one year’s time if invested elsewhere.
D) It does not consider whether the $10,000 will be needed elsewhere.
76) How can we convert the value of money from one point in time to another?
A) using the current exchange rate
B) using a cost benefit analysis
C) using the Valuation Principle
D) using the current interest rate
77) Owen expects to receive $20,000 at the end of next year from a trust fund. If a bank loans money at an
interest rate of 7.5%, how much money can he borrow from the bank on the basis of this information?
A) $11,428
B) $15,000
C) $18,605
D) $21,500
78) Stella deposits $5,000 in a savings account at a bank that offers interest of 5.5% on such accounts. What is the
value of the money in her savings account in one year‘s time?
A) $4739
B) $5135
C) $5275
D) $7750
79) An investment will pay $205,000 at the end of next year for an investment of $183,000 at the start of the year.
If the market interest rate is 8% over the same period, should this investment be made?
A) No, because the investment will yield $6240 less than putting the money in a bank.
B) Yes, because the investment will yield $2360 more than putting the money in a bank.
C) Yes, because the investment will yield $4280 more than putting the money in a bank.
D) Yes, because the investment will yield $7360 more than putting the money in a bank.
80) If $476 invested today yields $500 in one year’s time, what is the discount factor?
A) 0.05
B) 0.95
C) 1.05
D) 1.50
81) A vintner is deciding when to release a vintage of sauvignon blanc. If it is bottled and released now, the
wine will be worth $2.2 million. If it is barrel aged for a further year, it will be worth 20% more, though
there will be additional costs of $500,000. If the interest rate is 7%, what is the difference in the benefit the
vintner will realize if he releases the wine after barrel aging it for one year or if he releases the wine now?
A) He will earn $600,000 less if he releases the wine now.
B) He will earn $60,000 less if he releases the wine now.
C) He will earn $107,000 less if he releases the wine now.
D) He will earn $80,000 more if he releases the wine now.
82) Samantha has holdings of 250 troy ounces of platinum, currently valued at $815 dollars per ounce. She
estimates that the price of platinum will rise to $850 per ounce in the next year. If the interest rate is 8%,
should she sell the platinum today?
A) Yes, as the difference between selling now and selling in one year is $7550 dollars today.
B) Yes, as the difference between selling now and selling in one year is $6991 dollars today.
C) Yes, as the difference between selling now and selling in one year is $5513 dollars today.
D) No, as the difference between selling now and selling in one year is –$6988 dollars today.
83) You are scheduled to receive $10,000 in one year. An increase in the interest rate will have what effect on
the present value of this cash flow?
A) It will cause the present value to fall.
B) It will cause the present value to rise.
C) It will have no effect on the present value.
D) The effect cannot be determined with the information provided.
84) You are scheduled to receive $10,000 in one year. An increase in the interest rate will have what effect on
the future value of this cash flow?
A) It will cause the future value to fall.
B) It will cause the future value to rise.
C) It will have no effect on the future value.
D) The effect cannot be determined with the information provided.
85) If the interest rate is 5%, the one–year discount factor is equal to:
A) 0.050.
B) 1.050.
C) 0.952.
D) 1.045
86) If the one–year discount factor is equal to 0.90909, the interest must be equal to:
A) 5.0%
B) 9.1%
C) 9.5%
D) 10.0%
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
87) Explain why a dollar today is worth more than a dollar tomorrow.
88) How can we make a financial decision with cash flows occurring at different points in time?
89) Is there a need to distinguish between cash inflows and outflows on a timeline?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
90) A dollar today and a dollar in one year may be considered to be equivalent.
91) The rule of 72 tells you approximately how long it takes for money invested at a given rate of compound
interest to double in value.
92) To calculate a cash flow’s present value (PV), you must compound it.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
93) What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per
year?
A) $60,000.00
B) $68,058.32
C) $73,502.99
D) $82,609.42