Deck 6: Financial Concepts and Interest Rates

Question 1

The interest rate is the price charged to a borrower for the loan of money.

Answer 1

True

Question 2

Any interest rate is a ratio of two quantities -- the denominator consists of the cash benefits promised to a lender of funds over a specified period of time and the numerator is the total amount of money loaned.

Answer 2

False

Question 3

By convention, all interest rates are expressed in percent per annum.

Answer 3

True

Question 4

A basis point is one hundredth of a percentage point.

Question 5

Suppose the interest rate on three-month U.S. Treasury bills rises from 7 percent to 11 percent. This change represents a gain of 400 basis points.

Question 6

Stock prices in the U.S. are measured in dollars and decimal fractions of a dollar, such as $40.25 per share.

Question 7

Bond prices in the U.S. are expressed in dollars and eighths of a dollar; for example, a bond quoted as 5-1/8 is really selling for $5.125.

Question 8

If you were interested in buying a bond listed on a security dealer's quote sheet at 96-5 points, you would have to pay $96,500 for the bond.

Question 9

Dealers in securities quote a bid price which means the price customers must bid for the dealers' securities in order to buy them.

Question 10

The spread between bid and asked prices quoted by a security dealer generally increases with longer maturities.

Question 11

The interest rate charged on a loan and its yield to the lender are one and the same thing.

Question 12

If a bond carries a coupon of $60 and a par value of $1,000, then its coupon rate must be 6 percent.

Question 13

The coupon rate is a useful measure of the rate of return on a bond because it takes into account fluctuations in the bond's market price.

Question 14

XYZ corporation's common stock is selling today at $40 per share; the company pays quarterly dividends of $2 per share. Thus, the stock's current yield is 5 percent.

Question 15

The current yield reflects the terminal (selling or redemption) price of a security.

Question 16

The yield to maturity on a security indicates the rate at which the market is prepared to exchange present dollars in exchange for future dollars promised by the security.

Question 17

The yield-to-maturity formula takes account of receipts of income from a security but not repayments of the principal of a loan.

Question 18

Yield to maturity is based upon par or book values not market values.

Question 19

The yield-to-maturity measure assumes the investor can reinvest all cash inflows from a security at the calculated yield to maturity.

Question 20

The holding-period yield on a security includes the selling price of the security.

Question 21

Both the yield-to-maturity and holding-period yield formulas are based upon the concept of present value.

Question 22

Suppose an investor is promised $1,200 one year from today with a promised interest rate of 18 percent. Then the present value of the $1,200 must be $1,010.

Question 23

Present-value tables may be used to calculate yield to maturity but not holding-period yield.

Question 24

A rise in interest rates means lower prices for bonds and other fixed-income securities.

Question 25

The curve depicting the supply of loanable funds is directly analogous to the curve depicting the demand for securities, according to your textbook.

Question 26

If the supply of loanable funds increases (demand unchanged), interest rates and security prices will tend to fall.

Question 27

An increase in the demand for loanable funds (supply unchanged) leads to higher interest rates and security prices.

Question 28

If a security's coupon rate equals the current market interest rate on comparable securities that security will trade at par.

Question 29

If a security's coupon rate is less than the prevailing market rate of interest it will sell at a discount from par.

Question 30

If a security's coupon rate is less than the prevailing market rate of interest it will sell at a premium above its par value.

Question 31

The yield to maturity formula assumes that an investor will hold a security until it reaches final maturity.

Question 32

For a debt security that pays interest semiannually the yield-to-maturity formula needs to be modified with both the figure for annual interest income and the yield multiplied by 2.

Question 33

The compounding of interest means that a lender of funds will earn interest income on both the principal amount and on accumulated interest.

Question 34

The longer the period of time over which interest earnings are compounded, the more rapidly does interest earned grow.

Question 35

The principal value of money invested at compound interest equals the sum of the principal plus all accumulated interest over the life of the investment divided by the compounding factor.

Question 36

The difference, FV-P, yields the amount of compound interest earned on an investment made at any particular compound rate, r, according to your textbook.

Question 37

Interest rates on U.S. Treasury bills, commercial paper and selected other short-term financial instruments are based on a 360-day year and do not compound interest.

Question 38

The spread between bid and ask prices of securities provides the security dealer's return for creating a market for a particular security.

Question 39

On very large security sales dealers often forego commissions and quote a net price.

Question 40

Under the terms of most fixed and variable-rate mortgage loans the monthly payments in the early life of a loan go almost entirely to pay the interest on the loan.

Question 41

Under the terms of most fixed and variable-rate mortgage loans the closer a home mortgage loan gets to maturity subsequent monthly payments will consist mostly of repaying the loan principal itself.

Question 42

Research has shown that consumers have benefited greatly from requiring lenders to quote an APR on their loans; individuals and families appear to be heavily influenced by these APR figures and vigorously shop around for credit when the lender's quoted APR seems too high.

Question 43

Most consumers give primary weight to the quoted APR on a loan and only secondary weight to the size of loan installment payments in deciding how much, when and where to borrow.

Question 44

If an individual or a family can afford both the principal and the interest a lender proposes to charge on a loan, they seem little influenced by the reported size of the APR on that loan.

Question 45

There is considerable research evidence that passage of Truth in Lending has encouraged consumers to vigorously shop around for credit and to compare prices.

Question 46

Home buyers pay more in principal than they do in interest over the life of their mortgage loan.

Question 47

Consumers appear to base their borrowing decisions on the APR quoted by different lenders.

Question 48

Consumers appear to ignore the APR quoted by lenders and base their borrowing decisions on the size of the monthly installment payments.

Question 49

Most financial institutions offer their depositors compound interest today.

Question 50

Yield-to-maturity and holding period yield are good methods for measuring the true return from lending and investing.

Question 51

The Truth in Savings Act requires depository institutions in the U.S. to figure a customer's interest return on the amount of his or her lowest account balance.

Question 52

A customer opening a new deposit account in the United States is entitled to have the return on his or her deposit calculated on the average balance, not the lowest balance, in his or her account.

Question 53

Although seldom seen in the U.S., discount method loans are still quite popular in Latin America.

Question 54

When a bank customer borrows, the bank gives her the APR. When she deposits funds, she is given the APY.

Question 55

The wholesale money market is away on large sums of money are lined for short periods of time of up to one year.

Question 56

Most money market assets are short-term assets in which the investor receives no income until the asset matures.

Question 57

Par value or face value is the amount that the investor receives upon maturity of the asset.

Question 58

Investment rate of return is also referred to as the coupon-equivalent or bond-equivalent.

Question 59

The discount rate (DR) is always less than the investment rate (IR).

Question 60

T-Bills are U.S. Treasury bills that are money market assets that may have maturities upon issue of four weeks, three months, six months or one year.

Question 61

The Bid rate is the discount rate that the dealer requires as he is to purchase the T-bill and add it to his portfolio.

Question 62

Money market assets such as US treasury bills are sold at a discount.

Question 63

US treasury bills or corporate bonds represent a stream of future payments rather than a single lump sum payment received upon maturity.

Question 64

A firm expected to experience rapid growth in earnings in the future it will tend to have high stock prices in relation to their prior year's earnings and hence a low PE.

Question 65

The yield to maturity represents the rate of return an investor would receive if he bought the asset and chose to hold the asset for its entire life.

Question 66

The revenue stream associated with a bond normally consists of a number of identical periodic coupon payments plus the par value of the bond received at maturity.

Question 67

The most common periodic timeframe for coupon payments from bonds is semiannually.

Question 68

If the yield to maturity and coupon rate are the same, then the bond price will be equal to the par value of the bond.

Question 69

The annualized holding period yield (h) is simply the rate of discount equalizing the market price of the debt security worth all annual payments between the time the asset was purchased and the time it is sold.

Question 70

The "Asked Yield" is the yield to maturity an investor purchasing the Treasury from the Dealer would receive if he bought the security and held it to maturity.

Question 71

In price quotations on corporate bonds, the value of the estimated yield spread is given in basis points.

Question 72

Perpetual financial instruments may be either a fixed income securities or variable return assets, such as corporate stock.

Question 73

The British consol is a variable income perpetual financial instrument issued by the British government that promises its holder a fixed coupon payment every year ad infinitum.

Question 74

The most common form of a perpetual financial instrument is corporate stocks and U.S. Treasury bonds.

Question 75

The contracted rate which a bond issuer agrees to pay at the time a security is issued is the:

A) Coupon rate
B) Current yield
C) Yield to maturity
D) Holding period yield
E) Simple interest rate
F) Add-on rate
G) Discount rate
H) Annual percentage rate (APR)

Question 76

The ratio of the annual income (dividends or interest) generated by a security to its current market value is the:

A) Coupon rate
B) Current yield
C) Yield to maturity
D) Holding period yield
E) Simple interest rate
F) Add-on rate
G) Discount rate
H) Annual percentage rate (APR)

Question 77

The rate which equates the purchase price of a security with the present value of all its expected annual net cash inflows is the:

A) Yield to maturity
B) Annual percentage rate (APR)
C) Add-on interest rate
D) Coupon rate
E) Simple interest rate
F) Current yield
G) Holding-period yield
H) Discount rate

Question 78

The rate of discount equalizing the market price of a security with all net cash flows expected between the time the asset is purchased and the time it is sold is known as the:

A) Simple interest rate
B) Current yield
C) Discount rate
D) Coupon rate
E) Holding-period yield
F) Add-on interest rate
G) Annual percentage rate (APR)
H) Yield to maturity

Question 79

The interest rate on a loan which charges the borrowing customer only for the period of time the borrower actually has use of borrowed funds and may be derived from the formula I = Pxrxt is the:

A) Discount rate
B) Annual percentage rate (APR)
C) Simple interest rate
D) Current yield
E) Yield to maturity
F) Holding-period yield
G) Add-on rate
H) Coupon rate

Question 80

The interest rate figured on the full principal of the loan with the sum of interest and principal payments divided by the number of payments to determine the dollar amount of each payment is the:

A) Annual percentage rate (APR)
B) Yield to maturity
C) Coupon rate
D) Discount rate
E) Simple interest rate
F) Add-on rate
G) Holding-period yield
H) Current yield