# FIN534 -Quiz 3

**Question 1**

Which of the following statements is CORRECT?

Answer

If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.

If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.

To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the FV of the negative CFs. It is impossible to find the value of I without a computer or financial calculator.

If you solve for I and get a negative number, then you must have made a mistake.

If CF0 is positive and all the other CFs are negative, then you can still solve for I.

**Question 2**

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 lower the calculated value of the investment?

Answer

The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.

The discount rate increases.

The riskiness of the investment’s cash flows decreases.

The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.

The discount rate decreases.

**Question 3**

Which of the following statements is CORRECT?

Answer

The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.

If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.

The cash flows for an annuity due must all occur at the beginning of the periods.

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.

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.

**Question 4**

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

Answer

The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.

A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.

A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.

If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.

Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

**Question 5**

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?

Answer

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.

The discount rate decreases.

The riskiness of the investment’s cash flows increases.

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.

The discount rate increases.

**Question 6**

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

Answer

The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.

A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.

A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate.

If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.

Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

**Question 7**

You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

Answer

Bank 1; 6.1% with annual compounding.

Bank 2; 6.0% with monthly compounding.

Bank 3; 6.0% with annual compounding.

Bank 4; 6.0% with quarterly compounding.

Bank 5; 6.0% with daily (365-day) compounding.

**Question 8**

Which of the following bank accounts has the lowest effective annual return?

Answer

An account that pays 8% nominal interest with monthly compounding.

An account that pays 8% nominal interest with annual compounding.

An account that pays 7% nominal interest with daily (365-day) compounding.

An account that pays 7% nominal interest with monthly compounding.

An account that pays 8% nominal interest with daily (365-day) compounding.

**Question 9**

You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?

Answer

A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.

The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.

The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.

The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.

If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.

**Question 10**

Which of the following statements is CORRECT?

Answer

A time line is not meaningful unless all cash

flows occur annually.

Time lines are not useful for visualizing complex problems prior to doing actual calculations.

Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.

Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.

Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.

**Question 11**

A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

Answer

The annual payments would be larger if the interest rate were lower.

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.

The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.

The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.

The proportion of interest versus principal repayment would be the same for each of the 7 payments.

**Question 12**

Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

Answer

The monthly payments will increase over time.

A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.

The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity.

The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.

Exactly 10% of the first monthly payment represents interest.

**Question 13**

Which of the following statements is CORRECT?

Answer

A time line is not meaningful unless all cash flows occur annually.

Time lines are not useful for visualizing complex problems prior to doing actual calculations.

Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.

Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.

**Question 14**

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

Answer

The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.

Because the outstanding balance declines over time, the monthly payments will also decline over time.

Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.

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.

The outstanding balance declines at a faster rate in the later years of the loan’s life.

**Question 15**

Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

Answer

The monthly payments will decline over time.

A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.

The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.

The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.

Exactly 10% of the first monthly payment represents interest.

**Question 16**

You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

Answer

The price of Bond B will decrease over time, but the price of Bond A will increase over time.

The prices of both bonds will remain unchanged.

The price of Bond A will decrease over time, but the price of Bond B will increase over time.

The prices of both bonds will increase by 7% per year.

The prices of both bonds will increase over time, but the price of Bond A will increase by more.

**Question 17**

Which of the following bonds has the greatest interest rate price risk?

Answer

A 10-year $100 annuity.

A 10-year, $1,000 face value, zero coupon bond.

A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.

All 10-year bonds have the same price risk since they have the same maturity.

A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

**Question 18**

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?

Answer

If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current price.

The bond is selling below its par value.

The bond is selling at a discount.

If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current price.

The bond’s current yield is greater than 9%.

**Question 19**

Tucker Corporation is planning to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

Answer

Because of the call premium, the required rate of return would decline.

There is no reason to expect a change in the required rate of return.

The required rate of return would decline because the bond would then be less risky to a bondholder.

The required rate of return would increase because the bond would then be more risky to a bondholder.

It is impossible to say without more information.

**Question 20**

Which of the following statements is CORRECT?

Answer

All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds.

All else equal, long-term bonds have less interest rate price risk than short-term bonds.

All else equal, low-coupon bonds have less interest rate price risk than high-coupon bonds.

All else equal, short-term bonds have less reinvestment rate risk than long-term bonds.

All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.

**Question 21**

Which of the following statements is CORRECT?

Answer

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.

A sinking fund provision makes a bond more risky to investors at the time of issuance.

Sinking fund provisions never require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time.

If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.

**Question 22**

Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?

Answer

An 8-year bond with a 9% coupon.

A 1-year bond with a 15% coupon.

A 3-year bond with a 10% coupon.

A 10-year zero coupon bond.

A 10-year bond with a 10% coupon.

**Question 23**

Which of the following statements is CORRECT?

Answer

If the maturity risk premium were zero and interest rates were expected to decrease

in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.

Liquidity premiums are generally higher on Treasury than corporate bonds.

The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.

Default risk premiums are generally lower on corporate than on Treasury bonds.

Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

**Question 24**

A 12-year bond has an annual coupon rate of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

Answer

If market interest rates decline, the price of the bond will also decline.

The bond is currently selling at a price below its par value.

If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.

The bond should currently be selling at its par value.

If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.

**Question 25**

Which of the following statements is NOT CORRECT?

Answer

If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.

All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.

If a bond is selling at its par value, its current yield equals its yield to maturity.

If a bond is selling at a premium, its current yield will be greater than its yield to maturity.

All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.

**Question 26**

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?

Answer

The prices of both bonds will decrease by the same amount.

Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

The prices of both bonds would increase by the same amount.

One bond's price would increase, while the other bond’s price would decrease.

The prices of the two bonds would remain constant.

**Question 27**

Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?

Answer

10-year, zero coupon bond.

20-year, 10% coupon bond.

20-year, 5% coupon bond.

1-year, 10% coupon bond.

20-year, zero coupon bond.

**Question 28**

A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?

Answer

The bond sells at a price below par.

The bond has a current yield greater than 8%.

The bond sells at a discount.

The bond’s required rate of return is less than 7.5%.

If the yield to maturity remains constant, the price of the bond will decline over time.

**Question 29**

Which of the following statements is CORRECT?

Answer

One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.

If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.

Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate price risk but less reinvestment rate risk.

Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.

**Question 30**

Which of the following statements is CORRECT?

Answer

If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.

On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.

On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.

If a coupon bond is selling at par, its current yield equals its yield to maturity.

The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B.

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