Question 1

An insurance company is trying to sell you a retirement annuity. The annuity will give you 20 payments with the first payment in 12 years when you retire. The insurance firm is asking you to pay $50,000 today. If this is a fair deal, what must the payment amount be (to the dollar) if the interest rate is 8%?

Accepted Answer

Using the formula PV = Pmt*(PVIFA), we can solve for Pmt. PVIFA for 8% and 20 years is 9.8183. Therefore, Pmt = $11,874. This means that if you pay $50,000 today, you will receive 20 payments of $11,874 starting in 12 years, which would be a fair deal at an 8% interest rate.

Question 2

You want to have $5 million when you retire in 40 years. You believe you can earn 9% per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes)

Accepted Answer

This can be solved using the formula: Payment = (Future Value / (((1+interest rate)^number of years) - 1)) * (1+interest rate)^(-1). Plugging in the given values, we get Payment = (5,000,000 / (((1+0.09)^40) - 1)) * (1+0.09)^(-1) = $14,798. Therefore, the best choice is C.

Question 3

Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny).

Accepted Answer

Investment A's future value is $18,000. Investment B's future value is approximately $21,094.67. The difference is -$3,094.67.

Question 4

You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may be explained by which one of the following:

Accepted Answer

A decrease in U.S. inflationary expectations would lead to a decrease in yields on corporate and Treasury bonds as investors would demand lower yields to compensate for lower expected inflation rates.

Question 5

An investment pays $400 in one year, X amount of dollars in two years, and $500 in 3 years. The total present value of all the cash flows (including X) is equal to $1500. If i is 6%, what is X?

Accepted Answer

We can use the formula for the present value of an annuity to find X: PV = X/1.06^2. We can also use the formula for the present value of a single sum to find the sum of the $400 and $500 payments in present value terms: 400/1.06 + 500/1.06^3 = 789.70. Therefore, the equation for the total present value of all the cash flows becomes: PV = 789.70 + X/1.06^2. Solving for X, we get X = (1500 - 789.70*1.06^2 - 400/1.06 - 500/1.06^3)*1.06^2 = $789.70. Therefore, the best choice is C.

Question 6

You buy an investment today for $9,000. You sell the investment in 120 days for $9,500. The effective annual rate on this investment is

Accepted Answer

The answer of You buy an investment today for $9,000....

Question 7

Inflation causes the demand curve for loanable funds to shift to the _____ and causes the supply curve to shift to the _____.

Accepted Answer

Inflation increases the demand for loanable funds as borrowers expect to repay loans with cheaper dollars in the future, shifting the demand curve to the right. Conversely, it decreases the supply of loanable funds as lenders demand higher interest rates to compensate for decreased purchasing power, shifting the supply curve to the left.

Question 8

If M > 1 and you solve the following equation to find i: PV * (1 + (i/M))M*N= FV, the i you get will be

Accepted Answer

The answer of If M > 1 and you solve...

Question 9

Classify each of the following in terms of their effect on interest rates (increase or decrease):
I. Perceived risk of financial securities increases
II. Near term spending needs decrease
III. Future profitability of real investments increases

Accepted Answer

The answer of Classify each of the following in terms...

Question 10

A bank manager lends a corporate client $1,000,000 for six months. The bank charges a $1,000 fee to set up the loan. The corporate borrower repays $1,050,000 in six months. What is the effective annual rate on the loan?

Accepted Answer

Using the formula for effective annual rate (EAR), the calculation is:

EAR = [(1 + periodic rate)^m - 1]
where periodic rate = (Interest + fee)/principal
m = number of periods per year = 12/6 = 2

Plugging in the numbers:
EAR = [(1 + (50,000/1,000,000 + 1,000)/2)^2 - 1] = 0.1047 or 10.47%

Therefore, the answer is D: 10.47%.

Question 11

An investor wants to be able to buy 4% more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2%. Which statement(s) below is/are true?
I. 4% is the desired real rate of interest
II. 6% is the approximate nominal rate of interest required
III. 2% is the expected inflation rate over the period

Accepted Answer

The investor wants a 4% increase in purchasing power, which is the real rate. The nominal rate is approximately the real rate plus inflation, so 4% + 2% = 6%. The expected inflation rate is given as 2%.

Question 12

Of the following, the most likely effect of an increase in income tax rates would be to

Accepted Answer

An increase in income tax rates would likely decrease disposable income, leading to a decrease in savings rates as individuals have less money to save. This decrease in savings would also decrease the supply of loanable funds, as there would be less money available for lending. With a decrease in the supply of loanable funds, interest rates would increase due to the increased demand for funds. Therefore, all of the above options (decrease in savings rate, decrease in supply of loanable funds, and increase in interest rates) would be likely outcomes of an increase in income tax rates.

Question 13

Classify each of the following in terms of their effect on interest rates (increase or decrease):
I. Covenants on borrowing become more restrictive
II. The Federal Reserve increases the money supply
III. Total household wealth increases

Accepted Answer

The answer of Classify each of the following in terms...

Question 14

You borrow $95 today for six and a half weeks. You must repay $100 at loan maturity. What is the effective annual rate on this loan?

Accepted Answer

We can use the formula for effective annual rate:

(1 + EAR) = (1 + periodic rate)^n

Where n is the number of periods in a year. In this case, the loan is for 6.5 weeks, which is approximately 0.125 years (6.5/52). The periodic rate can be found by dividing the total interest paid by the principal borrowed:

$100 - $95 = $5 in interest
$5/$95 = 0.0526

So the periodic rate is approximately 5.26%. Plugging in these values, we get:

(1 + EAR) = (1 + 0.0526)^8
EAR = (1.0526)^8 - 1
EAR = 0.5073 or 50.73%

Therefore, the best choice is A.

Question 15

An annuity and an annuity due with the same number of payments have the same future value if r = 10%. Which one has the higher payment?

Accepted Answer

The answer of An annuity and an annuity due with...

Question 16

To the nearest basis point, what is the expected interest rate on a four-year maturity AA zero coupon bond purchased six years from today?

Accepted Answer

The answer of To the nearest basis point, what is...

Question 17

Upon graduating from college this year you expect to earn $25,000 per year. If you get your MBA, in one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5%. In today's dollars, how much additional (less) money will you make from getting your MBA (to the nearest dollar) in your first year?

Accepted Answer

The answer of Upon graduating from college this year you...

Question 18

You buy a car for $38,000. You agree to a 60-month loan with a monthly interest rate of 0.55%. What is your required monthly payment?

Accepted Answer

Using the formula Pmt = 38,000/PVIFA (i = 0.55%, n = 60), we get Pmt = 38,000/26.593 = $1,429.70. Therefore, the required monthly payment is $745.29 (rounded to the nearest cent).

Question 19

You just bought a fifteen-year maturity Xerox corporate bond rated AA with a 0% coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).

Accepted Answer

The answer of You just bought a fifteen-year maturity Xerox...

Question 20

According to the liquidity premium theory of interest rates,

Accepted Answer

The liquidity premium theory of interest rates asserts that long-term spot rates will be higher than the average of current and expected future short-term rates, reflecting a premium that investors require for investing in longer-term securities given the uncertainty of future events.

Quiz 2: Determinants of Interest Rates

You want to have $5 million when you retire in 40 years. You believe you can earn 9% per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes)

Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny) .

You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may be explained by which one of the following:

An investment pays $400 in one year, X amount of dollars in two years, and $500 in 3 years. The total present value of all the cash flows (including X) is equal to $1500. If i is 6%, what is X?

You buy an investment today for $9,000. You sell the investment in 120 days for $9,500. The effective annual rate on this investment is

Inflation causes the demand curve for loanable funds to shift to the _ and causes the supply curve to shift to the _.

If M > 1 and you solve the following equation to find i: PV * (1 + (i/M) ) M*N= FV, the i you get will be

Classify each of the following in terms of their effect on interest rates (increase or decrease) : I. Perceived risk of financial securities increases II. Near term spending needs decrease III. Future profitability of real investments increases