Deck 27: The Basic Tools of Finance

Question 1

The sooner a payment is received and the higher the interest rate,the greater the present value of a future payment.

Answer 1

False

Question 2

According to the rule of 70,if you earn an interest rate of 3.5 percent,your savings will double about every 20 years.

Answer 2

True

Question 3

The present value of any future sum of money is the amount that would be needed today,at current interest rates,to produce that future sum.

Answer 3

True

Question 4

People who are risk averse dislike bad outcomes more than they like comparable good outcomes.

Question 5

The present value of $100 to be paid in two years is less than the present value of $100 to be paid in three years.

Question 6

If a savings account pays 5 percent annual interest,then the rule of 70 tells us that the account value will double in approximately 14 years.

Question 7

If the interest rate is 8 percent,then the present value of $1,000 to be received in 4 years is $735.03.

Question 8

A person with diminishing marginal utility of wealth is risk averse.

Question 9

The market for insurance is an example of diversification.

Question 10

Historically the return on stocks has been higher than the return on bonds.In part this reflects the higher risk from holding stock.

Question 11

The future value of $1 saved today is $1/(1 + r).

Question 12

As the interest rate increases,the present value of future sums decreases,so firms will find fewer investment projects profitable.

Question 13

Risk-averse persons will take no risks.

Question 14

A person's subjective measure of well-being or satisfaction is called aversion.

Question 15

The market for insurance is one example of reducing risk by using diversification.

Question 16

If you are faced with the choice of receiving $500 today or $800 6 years from today,you will be indifferent between the two possibilities if the interest rate is 8.148 percent.

Question 17

Historically,stocks have offered higher rates of return than bonds.

Question 18

A company that can build a project that will cost $50,000,but returns $52,000 in one year would make a good decision by turning this project down if the interest rate were 3 percent.

Question 19

Risk aversion simply means that people dislike bad things to happen.

Question 20

Risk-averse individuals like good things more than they dislike comparable bad things.

Question 21

As the interest rate increases,what happens to the present value of a future payment? Explain why changes in the interest rate will lead to changes in the quantity of loanable funds demanded and investment spending.

Question 22

If you believe the stock market is informationally efficient,then it is a waste of time to engage in fundamental analysis.

Question 23

Increasing the number of corporations whose stocks are in your portfolio reduces market risk.

Question 24

List three different ways that a risk-averse person can reduce financial risk.

Question 25

Studies find that mutual fund managers who do well in one year,are likely to do well the next year.

Question 26

Write the rule of 70.Suppose that your great-great-grandmother put $50 in a savings account 100 years ago and the account is now worth $1,600.Use the rule of 70 to determine about what interest rate she earned.

Question 27

Diversification can reduce firm-specific risk.

Question 28

According to fundamental analysis,when choosing stocks for your portfolio,you should prefer undervalued stocks.

Question 29

According to the efficient markets hypothesis,stocks follow a random walk so that stocks that increase in price one year are more likely to increase than decrease in the next year.

Question 30

Available evidence indicates that stock prices,even if not exactly a random walk,are very close to a random walk.

Question 31

Adverse selection is illustrated by people who take greater risks after they purchase insurance.

Question 32

What's the difference between firm-specific risk and market risk? Will diversification eliminate one or both? Explain.

Question 33

If you wish to rely on fundamental analysis to choose a portfolio of stocks,then you have no choice but to do all the necessary research yourself.

Question 34

According to the efficient markets hypothesis,at any moment in time,the market price is the best estimate of the company's value based on publicly available information.

Question 35

The value of a stock depends on the ability of the company to generate dividends and the expected price of the stock when the stockholder sells her shares.

Question 36

According to the efficient markets hypothesis,the number of people who think a stock is overvalued exactly balances the number of people who think a stock is undervalued.

Question 37

Speculative bubbles may arise in part because the value of the stock to a stockholder depends on the final sale price.

Question 38

Managed mutual funds usually outperform mutual funds that are supposed to follow some stock index.

Question 39

Give an example of adverse selection and an example of moral hazard using homeowners insurance.

Question 40

Demonstrate that whether you would prefer to have $225 today or wait five years for $300 depends on the interest rate.Show your work.

Question 41

Suppose you put $500 into a bank account today.Interest is paid annually and the annual interest rate is 5.5 percent.The future value of the $500 is

A) $637.50 after 5 years and $822.09 after 10 years.
B) $637.50 after 5 years and $775.00 after 10 years.
C) $653.48 after 5 years and $854.07 after 10 years.
D) $688.36 after 5 years and $915.56 after 10 years.

Question 42

Imagine that someone offers you $1,000 today or $X in 7 years.If the interest rate is 4.5 percent,then you would prefer to take the $1,000 today if and only if

A) X < 1,045.00.
B) X < 1,188.89.
C) X < 1,266.67.
D) X < 1,360.86.

Question 43

The field of finance primarily studies

A) how society manages its scarce resources.
B) the implications of time and risk for allocating resources over time.
C) firms' decisions concerning how much to produce and what price to charge.
D) how society can reduce market risk.

Question 44

If the interest rate is 7.5 percent,then what is the present value of $4,000 to be received in 6 years?

A) $2,420.68
B) $2,591.85
C) $2,996.33
D) $3,040.63

Question 45

Compounding refers directly to

A) finding the present value of a future sum of money.
B) finding the future value of a present sum of money.
C) changes in the interest rate over time on a bank account or a similar savings vehicle.
D) interest being earned on previously-earned interest.

Question 46

In the 1990s,several stocks had very,very high price to earnings ratios.These stocks appeared overvalued to many observers.What might the people who bought them have been thinking?

Question 47

Which of the following statements best describes the economist's view of finance and the financial system?

A) The financial system is very important to the functioning of the economy,and the tools of finance are often helpful to us as individuals when we find ourselves making certain decisions.
B) The financial system,while interesting,is not very important to the functioning of the economy;however,the tools of finance are often helpful to us as individuals when we find ourselves making certain decisions.
C) The financial system is very important to the functioning of the economy;however,the tools of finance are not particularly helpful to us as individuals since we seldom make decisions for which those tools are useful .
D) The field of finance is intimately concerned with the financial system and the tools of finance,and financial economists see great importance in them;however,the "mainstream" economist sees little value in studying financial markets or the tools of finance.

Question 48

Discuss the statistical evidence concerning the efficient markets hypothesis.

Question 49

Draw graphs showing the following three relationships.
1.The relation between utility and wealth for a risk averse consumer.
2.The relation between standard deviation and the number of stocks in a portfolio.
3.The relation between return and risk

Question 50

Most financial decisions involve two related elements:

A) advice and consent.
B) investment and taxes.
C) time and risk.
D) saving and consumption.

Question 51

Imagine that someone offers you $100 today or $200 in 10 years.You would prefer to take the $100 today if the interest rate is

A) 4 percent.
B) 5 percent.
C) 6 percent.
D) None of the above are correct.

Question 52

Discounting refers directly to

A) finding the present value of a future sum of money.
B) finding the future value of a present sum of money.
C) calculations that ignore the phenomenon of compounding for the sake of ease and simplicity.
D) decreases in interest rates over time,while compounding refers to increases in interest rates over time.

Question 53

Suppose you put $350 into a bank account today.Interest is paid annually and the annual interest rate is 6 percent.The future value of the $350 after 4 years is

A) $414.09.
B) $434.00.
C) $441.87.
D) $481.24.

Question 54

The financial system

A) involves bank accounts,mortgages,stock prices,and many other items.
B) involves decisions and actions undertaken by people at a point in time that affect their lives in the future.
C) coordinates the economy's saving and investment.
D) All of the above are correct.

Question 55

Imagine that someone offers you $1,000 today or $1,500 in 5 years.You would prefer to take the $1,500 in 5 years if the interest rate is

A) 7 percent.
B) 10 percent.
C) 12 percent.
D) All of the above are correct.

Question 56

Imagine that someone offers you $100 today or $200 in 10 years.You would prefer to take the $100 today if the interest rate is

A) 4 percent.
B) 6 percent.
C) 8 percent.
D) All of the above are correct.

Question 57

Imagine that someone offers you $X today or $1,500 in 5 years.If the interest rate is 6 percent,then you would prefer to take the $X today if and only if

A) X > 1,055.56.
B) X > 1,120.89.
C) X > 1,213.33.
D) X > 1,338.26.

Question 58

In which of the following instances is the present value of the future payment the largest?

A) You will receive $1,000 in 5 years and the annual interest rate is 5 percent.
B) You will receive $1,000 in 10 years and the annual interest rate is 3 percent.
C) You will receive $2,000 in 10 years and the annual interest rate is 10 percent.
D) You will receive $2,400 in 15 years and the annual interest rate is 8 percent.

Question 59

Suppose you will receive $500 at some point in the future.If the annual interest rate is 7.5 percent,then the present value of the $500 is

A) $411.26 if the $500 is to be received in 5 years and $338.95 if the $500 is to be received in 10 years.
B) $348.28 if the $500 is to be received in 5 years and $242.60 if the $500 is to be received in 10 years.
C) $291.11 if the $500 is to be received in 5 years and $272.89 if the $500 is to be received in 10 years.
D) $291.11 if the $500 is to be received in 5 years and $236.49 if the $500 is to be received in 10 years.

Question 60

Give two conditions that are important to the efficient market theory.List one implication of the efficient market theory.

Question 61

At an annual interest rate of 10 percent,about how many years will it take $100 to double in value?

A) 5
B) 7
C) 9
D) 11

Question 62

Which of the following is the correct way to compute the future value of $X that earns r percent interest for N years?

A) $X(1 + rN)^N
B) $X(1 + r)^N
C) $X(1 + rN)
D) $X(1 + r/N)N

Question 63

What is the future value of $750 one year from today if the interest rate is 3 percent?

A) 772.73
B) 772.50
C) 773.33
D) None of the above are correct to the nearest cent.

Question 64

The future value of a deposit in a savings account will be smaller

A) the longer a person waits to withdraw the funds.
B) the lower the interest rate is.
C) the larger the initial deposit is.
D) All of the above are correct.

Question 65

A manufacturing company is thinking about building a new factory.The factory,if built,will yield the company $300 million in 7 years,and it would cost $220 million today to build.The company will decide to build the factory if the interest rate is

A) no less than 4.53 percent.
B) no greater than 4.53 percent.
C) no less than 5.81 percent.
D) no greater than 5.81 percent.

Question 66

If you put $250 into an account with a 4 percent interest rate,how many years would you have to wait to have $370.06?

A) 10
B) 14
C) 17
D) 20

Question 67

At an annual interest rate of 14 percent,about how many years will it take $100 to double in value?

A) 3
B) 4
C) 5
D) 7

Question 68

Which of the following is the correct way to compute the future value of $1 put into an account that earns 5 percent interest for 20 years?

A) $1(1 + .05)²⁰
B) $1(1 + .0520)20
C) $1(1 + .0520)
D) $1(1 + 20/.05)²⁰

Question 69

Which of the following is the correct way to compute the future value of $100 put into an account that earns 4 percent interest for 10 years?

A) $100(1 + .04¹⁰)
B) $100(1 + .0410)
C) $100 x 10 x (1 + .04)
D) $100(1 + .04)¹⁰

Question 70

Suppose you are deciding whether or not to buy a particular bond.If you buy the bond and hold it for 5 years,then at that time you will receive a payment of $10,000.If the interest rate is 6 percent,you will buy the bond if its price today is no greater than

A) $8,225.06.
B) $7,652.58.
C) $7,472.58.
D) $6,998.98.

Question 71

If you presently have $50,000 saved and earn 15 percent interest per year,about how many years will it take for your investment to triple?

A) 6
B) 8
C) 10
D) 12

Question 72

At an annual interest rate of 10 percent,about how many years will it take $100 to triple in value?

A) 8
B) 10
C) 12
D) 14

Question 73

What is the future value of $450 at an interest rate of 15 percent two years from today?

A) $525.87
B) $566.00
C) $585.00
D) $595.13

Question 74

What is the future value of $333 at an interest rate of 3 percent one year from today?

A) $337.39
B) $342.99
C) $343.09
D) None of the above are correct to the nearest cent.

Question 75

The future value of a deposit in a savings account will be larger

A) the longer a person waits to withdraw the funds.
B) the higher the interest rate is.
C) the larger the initial deposit is.
D) All of the above are correct.

Question 76

Suppose you are deciding whether or not to buy a particular bond for $2,990.08.If you buy the bond and hold it for 5 years,then at that time you will receive a payment of $5,000.You will buy the bond today if the interest rate is

A) no less than 9.48 percent.
B) no greater than 9.48 percent.
C) no less than 10.83 percent.
D) no greater than 10.83 percent.

Question 77

What is the future value of $800 one year from today if the interest rate is 7 percent?

A) $747.66
B) $756.00
C) $856.00
D) None of the above are correct to the nearest cent.

Question 78

You put $75 in the bank one year ago and forgot about it.The bank sends you a notice that you now have $81 in your account.What interest rate did you earn?

A) 5 percent
B) 6 percent
C) 7 percent
D) 8 percent

Question 79

What is the future value of $500 one year from today if the interest rate is 4 percent?

A) $515
B) $520
C) $530
D) None of the above is correct.

Question 80

At an annual interest rate of 20 percent,about how many years will it take $100 to triple in value?

A) 5
B) 6
C) 8
D) 9