Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Use the table for the question(s) below.
Consider the following investment alternatives:
Investment Rate Compounding
A6.25% Annual
B6.10% Daily
C6.125 Quarterly
D6.120 Monthly
1)
Which alternative offers you the highest effective rate of return?
1)
A)
Investment A
B)
Investment B
C)
Investment C
D)
Investment D
2)
Which of the following equations is incorrect?
2)
A)
Interest Rate per Compounding Period =APR
k periods / year
B)
1 +EAR =1 +APR
k
k
C)
Equivalent n–Period Discount Rate = (1 +r)n– 1
D)
k1 +EAR – 1=APR
Use the table for the question(s) below.
Consider the following investment alternatives:
Investment Rate Compounding
A6.25% Annual
B6.10% Daily
C6.125 Quarterly
D6.120 Monthly
3)
Which alternative offers you the lowest effective rate of return?
3)
A)
Investment A
B)
Investment B
C)
Investment C
D)
Investment D
Use the information for the question(s) below.
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a
new delivery truck for an upfront cost of $200,000, or you can lease a truck from the manufacturer for five years for a
monthly lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6% APR with quarterly
compounding.
4)
The present value of the lease payments for the delivery truck is closest to:
4)
A)
$207,680
B)
$198,420
C)
$206,900
D)
$207,050
Use the information for the question(s) below.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the
month) with a loan at 5.9% APR. You monthly payments are $617.16 and you have just made your 24th monthly payment
on your SUV.
5)
Assuming that you have made all of the first 24 payments on time, then the outstanding principal
balance on your SUV loan is closest to:
5)
A)
20,300
B)
$19,200
C)
$32,000
D)
$31,250
Use the information for the question(s) below.
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a
new delivery truck for an upfront cost of $200,000, or you can lease a truck from the manufacturer for five years for a
monthly lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6% APR with quarterly
compounding.
6)
The monthly discount rate that you should use to evaluate the truck lease is closest to:
6)
A)
0.500%
B)
0.512%
C)
0.498%
D)
0.487%
7)
Which of the following statements is false?
7)
A)
The highest interest rate, for a given horizon, is the rate paid on U.S. Treasury securities.
B)
The equivalent after–tax interest rate is r(1 –)
C)
It is important to use a discount rate that matches both the horizon and the risk of the cash
flows.
D)
The actual return kept by an investor will depend on how the interest is taxed.
Use the information for the question(s) below.
You are purchasing a new home and need to borrow $250,000 from a mortgage lender. The mortgage lender quotes you a
rate of 6.25% APR for a 30–year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay 2
points, they can offer you a lower rate of 6.0% APR for a 30–year fixed rate mortgage. One point is equal to 1% of the loan
value. So if you take the lower rate and pay the points you will need to borrow an additional $5000 to cover points you are
paying the lender.
8)
Assuming you don’t pay the points and borrow from the mortgage lender at 6.25%, then your
monthly mortgage payment (with payments made at the end of the month) will be closest to:
8)
A)
$1530
B)
$1540
C)
$1500
D)
$1570
Use the information for the question(s) below.
You are in the process of purchasing a new automobile that will cost you $27,500. The dealership is offering you either a
$2,500 rebate (applied toward the purchase price) or 1.9% financing for 48 months (with payments made at the end of the
month). You have been pre–approved for an auto loan through your local credit union at an interest rate of 6.5% for 48
months.
9)
If you forgo the $2,500 rebate and finance your new car through the dealership your monthly
payments (with payments made at the end of the month) will be closest to:
9)
A)
$593
B)
$652
C)
$541
D)
$595
10)
Which of the following statements is false?
10)
A)
An inverted yield curve generally signals an expected decline in future interest rates.
B)
All the formulas for computing present values of annuities and perpetuities are based upon
discounting all of the cash flows at the same rate.
C)
An inverted yield curve is often interpreted as a positive forecast for economic growth.
D)
The rate of growth of your purchasing power is determined by the real interest rate.
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%
11)
The NPV of an investment that costs $2700 and pays $1000 certain at the end of one, three, and five
years is closest to:
11)
A)
–100.26
B)
$1665.62
C)
21.47
D)
–71.38
12)
What is the shape of the yield curve and what expectations are investors likely to have about future
interest rates?
12)
A)
Normal; Lower
B)
Inverted; Higher
C)
Inverted; Lower
D)
Normal; Higher
13)
Which of the following statements is false?
13)
A)
The interest rates that banks offer on investments or charge on loans depends on the horizon
of the investment or loan.
B)
The Federal Reserve determines very short–term interest rates through its influence on the
federal funds rate.
C)
Fundamentally, interest rates are determined by the Federal Reserve.
D)
The interest rates that are quoted by banks and other financial institutions are nominal
interest rates.
Use the table for the question(s) below.
Consider the following investment alternatives:
Investment Rate Compounding
A6.25% Annual
B6.10% Daily
C6.125 Quarterly
D6.120 Monthly
14)
The highest effective rate of return you could earn on any of these investments is closest to:
14)
A)
6.310%
B)
6.300%
C)
6.267%
D)
6.250%
15)
Which of the following formulas is incorrect?
15)
A)
rri–r
B)
i=1 +r
1 +rr
– 1
C)
1 +rr=1 +r
1 +i
D)
rr=r–i
1 +i
Use the information for the question(s) below.
You are purchasing a new home and need to borrow $250,000 from a mortgage lender. The mortgage lender quotes you a
rate of 6.25% APR for a 30–year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay 2
points, they can offer you a lower rate of 6.0% APR for a 30–year fixed rate mortgage. One point is equal to 1% of the loan
value. So if you take the lower rate and pay the points you will need to borrow an additional $5000 to cover points you are
paying the lender.
16)
Assuming you pay the points and borrow from the mortgage lender at 6.00%, then your monthly
mortgage payment (with payments made at the end of the month) will be closest to:
16)
A)
$1540
B)
$1530
C)
$1500
D)
$1570
17)
Which of the following statements is false?
17)
A)
The nominal interest rate does not represent the increase in purchasing power that will result
from investing
B)
The plot of the relationship between the investment risk and the interest rate is call the yield
curve.
C)
Each of the last six recessions in the United States was preceded by a period with an inverted
yield curve.
D)
A risk–free cash flow received in two years should be discounted at the two–year interest
rate.
18)
Which of the following statements is false?
18)
A)
The yield curve is a potential leading indicator of future economic growth.
B)
The relationship between the investment term and the interest rate is called the term structure
of interest rates.
C)
Real interest rates indicate the rate at which your money will grow if invested for a certain
period.
D)
The shape of the yield curve will be strongly influenced by interest rate expectations.
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%
19)
The present value of receiving $1000 per year with certainty at the end of the next three years is
closest to:
19)
A)
$2,737
B)
$2,744
C)
$2,733
D)
$2,723
Use the table for the question(s) below.
Suppose you have the following Loans / Investments
Credit Card 14.90% APR (Monthly Compounding)
Automobile Loan 5.90% APR (Monthly Compounding)
Home Equity Loan 8.25% APR (Monthly Compounding)
Money Market Fund 5.10% EAR
20)
If your income tax rate is 30%, then the after–tax return you receive on your money market fund is
closest to:
20)
A)
5.1%
B)
3.7%
C)
4.2%
D)
3.6%
21)
The effective annual rate (EAR) for a loan with a stated APR of 10% compounded quarterly is
closest to:
21)
A)
10.52%
B)
10.38%
C)
10.25%
D)
10.00%
Use the information for the question(s) below.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the
month) with a loan at 5.9% APR. You monthly payments are $617.16 and you have just made your 24th monthly payment
on your SUV.
22)
The amount of your original loan is closest to:
22)
A)
$31,250
B)
$20,300
C)
$37,000
D)
$32,000
23)
Which of the following statements is false?
23)
A)
We can use the term structure to compute the present and future values of a risk–free cash
flow over different investment horizons.
B)
The yield curve changes over time.
C)
The yield curve tends to be inverted as the economy comes out of a recession.
D)
The formulas for computing present values of annuities and perpetuities cannot be used in
situations in which cash flows need to be discounted at different rates.
Use the table for the question(s) below.
Suppose you have the following Loans / Investments
Credit Card 14.90% APR (Monthly Compounding)
Automobile Loan 5.90% APR (Monthly Compounding)
Home Equity Loan 8.25% APR (Monthly Compounding)
Money Market Fund 5.10% EAR
24)
If your income tax rate is 30%, then the after–tax EAR for your home equity loan is closest to:
24)
A)
5.8%
B)
8.6%
C)
6.0%
D)
5.9%
25)
Which of the following statements is false?
25)
A)
Because interest rates may be quoted for different time intervals, it is often necessary to adjust
the interest rate to a time period that matches that of our cash flows.
B)
The annual percentage rate indicates the amount of interest including the effect of
compounding.
C)
The annual percentage rate indicates the amount of simple interest earned in one year.
D)
The effective annual rate indicates the amount of interest that will be earned at the end of one
year.
26)
The effective annual rate (EAR) for a savings account with a stated APR of 4% compounded daily is
closest to:
26)
A)
4.00%
B)
4.08%
C)
4.06%
D)
4.10%
27)
Which of the following statements is false?
27)
A)
Interest rates vary with the investment horizon.
B)
When we refer to the “risk–free interest rate,” we mean the rate on U.S. Treasuries.
C)
All borrowers, besides the U.S. Treasury, have some risk of default.
D)
When interest on a loan is tax deductible, the effective after–tax interest rate is × (1 –r).
28)
If the current inflation rate is 5%, then the nominal rate necessary for you to earn an 8% real interest
rate on your investment is closest to:
28)
A)
13.4%
B)
4.9%
C)
3.0%
D)
13.0%
29)
Assume that you presently have a monthly home mortgage with a stated interest rate of 7% APR.
If your income tax rate is 20%, then the after tax EAR for your home mortgage is closest to:
29)
A)
7.2%
B)
7.0%
C)
5.8%
D)
5.6%
30)
Which of the following statements is false?
30)
A)
U.S. Treasury securities are widely regarded to be risk–free because there is virtually no
chance the government will default on these bonds.
B)
Investors may receive less than the stated interest rate if the borrowing company has financial
difficulties and is unable to fully repay the loan.
C)
Taxes reduce the amount of interest the investor can keep, and we refer to this reduced
amount as the tax effective interest rate.
D)
In general, if the interest rate is r and the tax rate is , then for each $1 invested you will earn
interest equal to r and owe taxes of ×r on the interest.
Use the table for the question(s) below.
Consider the following investment alternatives:
Investment Rate Compounding
A6.25% Annual
B6.10% Daily
C6.125 Quarterly
D6.120 Monthly
31)
The lowest effective rate of return you could earn on any of these investments is closest to:
31)
A)
6.300%
B)
6.250%
C)
6.100%
D)
6.267%
32)
Which of the following statements is false?
32)
A)
The opportunity cost of capital is the return the investor forgoes when the investor takes on a
new investment.
B)
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.
C)
Interest rates we observe in the market will vary based on quoting conventions, the term of
investment, and risk.
D)
The investor’s opportunity cost of capital is the best available expected return offered in the
market on an investment of comparable risk and term of the cash flows being discounted.