Take Test: Quiz 3 (46/60=77)

Question 1
1. 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 lower the calculated value of the investment? Answer The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000. The discount rate increases. The riskiness of the investments cash flows decreases. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years. The discount rate decreases. 2 points

Question 2
1. Which of the following bank accounts has the highest effective annual return? Answer An account that pays 8% nominal interest with monthly compounding. An account that pays 8% nominal interest with annual compounding. An account that pays 7% nominal interest with daily (365-day) compounding. An account that pays 7% nominal interest with monthly compounding. An account that pays 8% nominal interest with daily (365-day) compounding. 2 points

Question 3

1. 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 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 investments 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. The discount rate increases. 2 points

Question 4 WRONG
1. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? Answer The periodic interest rate is greater than 3%. The periodic rate is less than 3%. The present value would be greater if the lump sum were discounted back for more periods. The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually. The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity. 2 points

Question 5

1. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) Answer The remaining balance after three years will be $125,000 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. The outstanding balance declines at a slower rate in the later years of the loans life. 2 points

Question 6 WRONG
1. Which of the following statements is CORRECT? Answer 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. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. 2 points

Question 7 WRONG
1.

Which of the following statements is CORRECT? Answer The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due. If a loan has a nominal annual rate of 8%, then the effective rate will never be less 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. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%. 2 points

Question 8
1. You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest? Answer Bank 1; 6.1% with annual compounding. Bank 2; 6.0% with monthly compounding. Bank 3; 6.0% with annual compounding. Bank 4; 6.0% with quarterly compounding. Bank 5; 6.0% with daily (365-day) compounding.

2 points

Question 9
1. Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

Answer 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%. Exactly 10% of the first monthly payment represents interest. 2 points

Question 10
1. You are considering two equally risky annuities, each of which pays $5,000 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 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. 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. 2 points

Question 11
1. Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

Answer The periodic rate of interest is 1.5% and the effective rate of interest is 3%. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%. The periodic rate of interest is 3% and the effective rate of interest is 6%. The periodic rate of interest is 6% and the effective rate of interest is also 6%. 2 points

Question 12
1. Which of the following bank accounts has the lowest effective annual return? Answer An account that pays 8% nominal interest with monthly compounding. An account that pays 8% nominal interest with annual compounding. An account that pays 7% nominal interest with daily (365-day) compounding. An account that pays 7% nominal interest with monthly compounding. An account that pays 8% nominal interest with daily (365-day) compounding. 2 points

Question 13 WRONG
1. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? Answer 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%. 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. 2 points

Question 14 WRONG
1. A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? Answer The annual payments would be larger if the interest rate were lower. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. The proportion of interest versus principal repayment would be the same for each of the 7 payments. 2 points

Question 15
1. Which of the following statements is CORRECT? Answer A time line is not meaningful unless all cash flows occur annually.

Time lines are not useful for visualizing complex problems prior to doing actual calculations. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts. 2 points

Question 16
1. A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT? Answer The bonds expected capital gains yield is positive. The bonds yield to maturity is 9%. The bonds current yield is 9%. If the bonds yield to maturity remains constant, the bond will continue to sell at par. The bonds current yield exceeds its capital gains yield.

2 points

Question 17 WRONG
1. You are considering two bonds. 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 price of Bond B will decrease over time, but the price of Bond A will increase

over time. 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.

2 points

Question 18
1. Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%

The differences in rates among these issues were most probably caused primarily by: Answer Real risk-free rate differences. Tax effects. Default risk differences. Maturity risk differences. Inflation differences.

2 points

Question 19
1. Which of the following statements is CORRECT? Answer

If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope. Liquidity premiums are generally higher on Treasury than corporate bonds. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds. Default risk premiums are generally lower on corporate than on Treasury bonds. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

2 points

Question 20
1. Which of the following statements is CORRECT? Answer 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. 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 investors standpoint than interest rate price risk if the investor has a short investment time horizon.

2 points

Question 21
1.

Amram Inc. 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, Amram 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 Amram would have to pay on the convertible, callable bond? Answer Exactly equal to 6%. It could be less than, equal to, or greater than 6%. Greater than 6%. Exactly equal to 8%. Less than 6%. 2 points

Question 22
1. Tucker Corporation is planning 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? Answer Because of the call premium, the required rate of return would decline. There is no reason to expect a change in the required rate of return. The required rate of return would decline because the bond would then be less risky to a bondholder. The required rate of return would increase because the bond would then be more risky to a bondholder. It is impossible to say without more information.

2 points

Question 23
1.

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? Answer The bonds coupon rate exceeds its current yield. The bonds current yield exceeds its yield to maturity. The bonds yield to maturity is greater than its coupon rate. The bonds current yield is equal to its coupon rate. If the yield to maturity stays constant until the bond matures, the bonds price will remain at $850.

2 points

Question 24
1. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? Answer The companys bonds are downgraded. Market interest rates rise sharply. Market interest rates decline sharply. The company's financial situation deteriorates significantly. Inflation increases significantly.

2 points

Question 25
1. Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?

Answer Adding additional restrictive covenants that limit management's actions. Adding a call provision. The rating agencies change the bond's rating from Baa to Aaa. Making the bond a first mortgage bond rather than a debenture. Adding a sinking fund.

2 points

Question 26
1. A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? Answer The prices of both bonds will decrease by the same amount. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. The prices of both bonds would increase by the same amount. One bond's price would increase, while the other bonds price would decrease. The prices of the two bonds would remain constant.

2 points

Question 27
1. Which of the following statements is CORRECT? Answer

A zero coupon bond's current yield is equal to its yield to maturity. If a bonds yield to maturity exceeds its coupon rate, the bond will sell at par. All else equal, if a bonds yield to maturity increases, its price will fall. If a bonds yield to maturity exceeds its coupon rate, the bond will sell at a premium over par. All else equal, if a bonds yield to maturity increases, its current yield will fall.

2 points

Question 28 WRONG
1. Which of the following statements is NOT CORRECT? Answer If a bond is selling at a discount to par, its current yield will be less than its yield to maturity. 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. 2 points

Question 29
1. 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 zero coupon bond.

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. 2 points

Question 30
1. A 12-year bond has an annual coupon rate of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? Answer If market interest rates decline, the price of the bond will also decline. The bond is currently selling at a price below its par value. If market interest rates remain unchanged, the bonds 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 bonds price one year from now will be higher than it is today.

2 points