FIN 534/FIN534 WEEK 4 QUIZ 3 (Solution 30/30) - 90618

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Question 1 Which of the following statements is CORRECT? Answer 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. 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 ends of the periods. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. 4 points Question 2 Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures? Answer $3,754.27 $3,941.99 $4,139.09 $4,346.04 $4,563.34 4 points Question 3 You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? Answer 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. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. 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 DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD. 4 points Question 4 Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? Answer 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. 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%. 4 points Question 5 You are considering two equally risky annuities, each of which pays $25,000 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 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. 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. 4 points Question 6 How much would Roderick have after 6 years if he has $500 now and leaves it invested at 5.5% with annual compounding? Answer $591.09 $622.20 $654.95 $689.42 $723.89 4 points Question 7 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 discount rate increases. 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. 4 points Question 8 Of the following investments, which would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero. Answer Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments). Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). Investment D pays $2,500 at the end of 10 years (just one payment). Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). 4 points Question 9 Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 8% is CORRECT? Answer Exactly 8% of the first monthly payment represents interest. 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 6% rather than 8%. 4 points Question 10 Which of the following statements is CORRECT? Answer 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. 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. 4 points Question 11 Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding? Answer $205.83 $216.67 $228.07 $240.08 $252.08 4 points Question 12 Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) Answer The outstanding balance declines at a slower rate in the later years of the loan's life. The remaining balance after three years will be $225,000 less one third of the interest paid during the first three years. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. 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. 4 points Question 13 Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? Answer 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. 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%. 4 points Question 14 Which of the following statements regarding a 20-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? Answer Exactly 10% of the first monthly payment represents interest. 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%. 4 points Question 15 Which of the following statements is CORRECT? Answer An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. 4 points Question 16 Which of the following statements is CORRECT? Answer 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. All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds. 4 points Question 17 Which of the following statements is CORRECT? Answer 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. If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity. 4 points Question 18 A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT? Answer 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. If market interest rates decline, the price of the bond will also decline. 4 points Question 19 Which of the following statements is CORRECT? Answer 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. 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. 4 points Question 20 Which of the following statements is CORRECT? Answer If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value. 4 points Question 21 Which of the following statements is NOT CORRECT? Answer 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. If a bond is selling at a discount to par, its current yield will be less than its yield to maturity. 4 points Question 22 Which of the following statements is CORRECT? Answer If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond. If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium. If a coupon bond is selling at a premium, its current yield equals its yield to maturity. If a coupon bond is selling at par, its current yield equals its yield to maturity. 4 points Question 23 Which of the following statements is CORRECT? Answer The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates. You hold two bonds. One is a 10-year, zero coupon, issue and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline. 4 points Question 24 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 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. The price of Bond B will decrease over time, but the price of Bond A will increase over time. 4 points Question 25 Which of the following statements is CORRECT? Answer An indenture is a bond that is less risky than a mortgage bond. The expected return on a corporate bond will generally exceed the bond's yield to maturity. If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity. Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated. All else equal, senior debt generally has a lower yield to maturity than subordinated debt. 4 points Question 26 If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value? Answer A 1-year bond with an 8% coupon. A 10-year bond with an 8% coupon. A 10-year bond with a 12% coupon. A 10-year zero coupon bond. A 1-year zero coupon bond. 4 points Question 27 Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? Answer The bond's current yield exceeds its yield to maturity. The bond's yield to maturity is greater than its coupon rate. The bond's current yield is equal to its coupon rate. If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850. The bond's coupon rate exceeds its current yield. 4 points Question 28 Which of the following statements is CORRECT? Answer If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par. All else equal, if a bond's yield to maturity increases, its price will fall. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par. All else equal, if a bond's yield to maturity increases, its current yield will fall. A zero coupon bond's current yield is equal to its yield to maturity. 4 points Question 29 The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT? Answer Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year. Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase. Bond A's current yield will increase each year. 4 points Question 30 Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT? Answer One year from now, Bond A's price will be higher than it is today. Bond A's current yield is greater than 8%. Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price. Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature. Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.
Solution Description

Question 1
Which of the following statements is CORRECT?
Answer
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.
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 ends of the periods.
The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.
4 points
Question 2
Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures?
Answer
$3,754.27
$3,941.99
$4,139.09
$4,346.04
$4,563.34
4 points
Question 3
You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?
Answer
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.
The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE.
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 DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.
4 points
Question 4
Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
Answer
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.
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%.
4 points
Question 5
You are considering two equally risky annuities, each of which pays $25,000 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
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.
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.
4 points
Question 6
How much would Roderick have after 6 years if he has $500 now and leaves it invested at 5.5% with annual compounding?
Answer
$591.09
$622.20
$654.95
$689.42
$723.89
4 points
Question 7
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

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