Q&A Hero

Q: For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures. a. True b. False

Q: The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present. a. True b. False

Q: Nicholas Industries can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Nicholas could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Nicholas would have to pay on the convertible, callable bond? a. It could be less than, equal to, or greater than 6%. b. Greater than 6%. c. Exactly equal to 8%. d. Less than 6%. e. Exactly equal to 6%.

Q: Which of the following statements is CORRECT? a. 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. b. A sinking fund provision makes a bond more risky to investors at the time of issuance. c. Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time. d. 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. e. 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.

Q: Ranger Inc. would like 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? a. There is no reason to expect a change in the required rate of return. b. The required rate of return would decline because the bond would then be less risky to a bondholder. c. The required rate of return would increase because the bond would then be more risky to a bondholder. d. It is impossible to say without more information. e. Because of the call premium, the required rate of return would decline.

Q: Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers no advantages to issuers. a. True b. False

Q: You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF. a. True b. False

Q: Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds. a. True b. False

Q: A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond. a. True b. False

Q: The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds. a. True b. False

Q: A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation. a. True b. False

Q: Sinking funds are devices used to force companies to retire bonds on a scheduled basis prior to their maturity. Many bond indentures allow the company to acquire bonds for a sinking fund by either purchasing bonds in the market or selecting the bonds to be acquired by a lottery administered by the trustee through a call at face value. a. True b. False

Q: A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates. a. True b. False

Q: If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk. a. True b. False

Q: Which of the following statements is NOT CORRECT? a. The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero. b. All else equal, senior debt has less default risk than subordinated debt. c. A company's bond rating is affected by its financial ratios and provisions in its indenture. d. Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the Act. e. All else equal, secured debt is less risky than unsecured debt.

Q: Which of the following statements is CORRECT? a. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%. b. The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant. c. For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds. d. When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized. e. The total return on a bond during a given year consists only of the coupon interest payments received.

Q: Which of the following statements is CORRECT? a. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond. b. Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees. c. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds. d. A firm with a sinking fund that gave it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate. e. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.

Q: 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

Q: 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

Q: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan). a. True b. False

Q: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year. a. True b. False

Q: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year. a. True b. False

Q: 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

Q: 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

Q: The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False

Q: The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False

Q: Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)a. Trueb. False

Q: Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)a. Trueb. False

Q: The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date. a. True b. False

Q: The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. a. True b. False

Q: A "growing annuity" is any cash flow stream that grows over time. a. True b. False

Q: A "growing annuity" is a cash flow stream that grows at a constant rate for a specified number of periods. a. True b. False

Q: If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate. a. True b. False

Q: If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate. a. True b. False

Q: 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

Q: 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

Q: 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

Q: 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

Q: 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

Q: Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts. a. True b. False

Q: Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods. a. True b. False

Q: Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. a. True b. False

Q: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False

Q: Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False

Q: A time line is not meaningful unless all cash flows occur annually. a. True b. False

Q: A time line is meaningful even if all cash flows do not occur annually. a. True b. False

Q: Starting to invest early for retirement reduces the benefits of compound interest. a. True b. False

Q: Starting to invest early for retirement increases the benefits of compound interest. a. True b. False

Q: Scott and Linda have been saving to pay for their daughter Casie's college education. Casie just turned 10 at (t = 0), and she will be entering college 8 years from now (at t = 8). College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years⎯if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 8, 9, 10, and 11).So far, Scott and Linda have accumulated $15,000 in their college savings account (at t = 0). Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4). Then they plan to make 3 equal annual contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at t = 5, 6, and 7 be to cover Casie's anticipated college costs?a. $1,965.21b. $2,068.64c. $2,177.51d. $2,292.12e. $2,412.76

Q: You are in negotiations to make a 7-year loan of $25,000 to DeVille Corporation. To repay you, DeVille will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. You are confident the payments will be made, since DeVille is essentially riskless. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?a. $4,271.67b. $4,496.49c. $4,733.15d. $4,969.81e. $5,218.30

Q: You plan to work for Strickland Corporation for 12 years after graduation and after that want to start your own business. You expect to save and deposit $7,500 a year for the first 6 years (t = 1 through t = 6) and $15,000 annually for the following 6 years (t = 7 through t = 12). The first deposit will be made a year from today. In addition, your grandmother just gave you a $25,000 graduation gift that you will deposit immediately (t = 0). If the account earns 9% compounded annually, how much will you have when you start your business 12 years from now?a. $238,176b. $250,712c. $263,907d. $277,797e. $291,687

Q: Julian and Jonathan are twin brothers (and so were born on the same day). Today, both turned 25. Their grandfather began putting $2,500 per year into a trust fund for Julian on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more $2,500 payments until a 46th and final payment is made on Julian's 65th birthday. The grandfather set things up this way because he wants Julian to work, not be a "trust fund baby," but he also wants to ensure that Julian is provided for in his old age.Until now, the grandfather has been disappointed with Jonathan and so has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Jonathan. He will make the first payment to a trust for Jonathan today, and he has instructed his trustee to make 40 additional equal annual payments until Jonathan turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Jonathan's trust today and each subsequent year to enable him to have the same retirement nest egg as Julian after the last payment is made on their 65th birthday?a. $3,726b. $3,912c. $4,107d. $4,313e. $4,528

Q: Your 75-year-old grandmother expects to live for another 15 years. She currently has $1,000,000 of savings, which is invested to earn a guaranteed 5% rate of return. If inflation averages 2% per year, how much can she withdraw (to the nearest dollar) at the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as inflation and thus enabling her to maintain a constant standard of living?a. $65,632b. $72,925c. $81,027d. $89,130e. $98,043

Q: You borrowed $50,000 which you must repay in 10 years. You plan to make an initial deposit today, then make 9 more deposits at the beginning of each the next 9 years, but with the deposits increasing at the inflation rate. You expect to earn 5% on your funds, and you expect a 3% inflation rate. To the nearest dollar, how large must your initial deposit be to enable you to reach your $50,000 target?a. $3,008b. $3,342c. $3,676d. $4,044e. $4,448

Q: On January 1, 2016, your sister's pet supplies business obtained a 30-year amortized mortgage loan for $250,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the interest tax deduction be for 2016?a. $17,419.55b. $17,593.75c. $17,769.68d. $17,947.38e. $18,126.85

Q: Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal?a. 73.67%b. 77.55%c. 81.63%d. 85.93%e. 90.45%

Q: You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,000 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning?a. 7.62%b. 8.00%c. 8.40%d. 8.82%e. 9.26%

Q: Your older brother turned 35 today, and he is planning to save $7,000 per year for retirement, with the first deposit to be made one year from today. He will invest in a mutual fund that's expected to provide a return of 7.5% per year. He plans to retire 30 years from today, when he turns 65, and he expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can he spend each year after he retires? His first withdrawal will be made at the end of his first retirement year.a. $58,601b. $61,686c. $64,932d. $68,179e. $71,588

Q: Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. How much would you still owe at the end of the first year, after you have made the first payment?a. $10,155.68b. $10,690.19c. $11,252.83d. $11,845.09e. $12,468.51

Q: Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. By how much would you reduce the amount you owe in the first year?a. $2,404.91b. $2,531.49c. $2,658.06d. $2,790.96e. $2,930.51

Q: Partners Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. An offer to lend you the $50,000 also comes from Community Bank, but it will charge 6.0%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks?a. 1.56%b. 1.30%c. 1.09%d. 0.91%e. 0.72%

Q: You just deposited $2,500 in a bank account that pays a 4.0% nominal interest rate, compounded quarterly. If you also add another $5,000 to the account one year (4 quarters) from now and another $7,500 to the account two years (8 quarters) from now, how much will be in the account three years (12 quarters) from now?a. $15,234.08b. $16,035.88c. $16,837.67d. $17,679.55e. $18,563.53

Q: Your Green Investment Tips subscription is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying $85 annually, beginning immediately, or you can get a lifetime subscription for $850, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy?a. 7.48b. 8.80c. 10.35d. 12.18e. 14.33

Q: The store where you bought new home furnishings offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?a. 12.31%b. 12.96%c. 13.64%d. 14.36%e. 15.08%

Q: You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $150,000?a. 39.60b. 44.00c. 48.40d. 53.24e. 58.57

Q: You are considering investing in a European bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $250,000? Round fractional months up.a. 23b. 27c. 32d. 38e. 44

Q: Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2?a. $7,531b. $7,927c. $8,323d. $8,740e. $9,177

Q: You plan to borrow $35,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?a. $1,994.49b. $2,099.46c. $2,209.96d. $2,326.27e. $2,442.59

Q: Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year?a. $1,200.33b. $1,263.50c. $1,330.00d. $1,400.00e. $1,470.00

Q: Your cousin will sell you his coffee shop for $250,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be?a. $4,029.37b. $4,241.44c. $4,464.67d. $4,699.66e. $4,947.01

Q: Suppose you are buying your first home for $145,000, and you have $15,000 for your down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be?a. $741.57b. $780.60c. $821.69d. $862.77e. $905.91

Q: Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be?a. $3,704.02b. $3,889.23c. $4,083.69d. $4,287.87e. $4,502.26

Q: Suppose you deposited $5,000 in a bank account that pays 5.25% with daily compounding based on a 360-day year. How much would be in the account after 8 months, assuming each month has 30 days?a. $5,178.09b. $5,436.99c. $5,708.84d. $5,994.28e. $6,294.00

Q: Billy Thornton borrowed $20,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Billy have to pay in a 30-day month?a. $120.83b. $126.88c. $133.22d. $139.88e. $146.87

Q: Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?a. 15.27%b. 16.08%c. 16.88%d. 17.72%e. 18.61%

Q: Pacific Bank pays a 4.50% nominal rate on deposits, with monthly compounding. What effective annual rate (EFF%) does the bank pay?a. 3.72%b. 4.13%c. 4.59%d. 5.05%e. 5.56%

Q: Suppose People's bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $250.00 at the end of each quarter and then pay off the principal amount at the end of the year. What is the effective annual rate on the loan?a. 8.46%b. 8.90%c. 9.37%d. 9.86%e. 10.38%

Q: Suppose United Bank offers to lend you $10,000 for one year at a nominal annual rate of 8.00%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. What is the effective annual rate on the loan?a. 8.24%b. 8.45%c. 8.66%d. 8.88%e. 9.10%

Q: Southwestern Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Woodburn Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Woodburn versus the rate charged by Southwestern?a. 0.52%b. 0.44%c. 0.36%d. 0.30%e. 0.24%

Q: American Express and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 18.00%, with interest paid monthly, what is the card's EFF%?a. 18.58%b. 19.56%c. 20.54%d. 21.57%e. 22.65%