## FIN 534 quiz 3

Question 1

Which of the following statements is CORRECT?

Answer

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. | ||

If some cash flows occur at the beginningof the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. |

2 points

Question 2

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 3

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 4

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 5

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 6

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 smaller if interest were compounded monthly rather than semiannually. | ||

The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity. |

2 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 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 investment’s 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 8

Which of the following statements is CORRECT?

Answer

If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0. | ||

If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost. | ||

To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the FV of the negative CFs. It is impossible to find the value of I without a computer or financial calculator. | ||

If you solve for I and get a negative number, then you must have made a mistake. | ||

If CF0is positive and all the other CFs are negative, then you can still solve for I. |

2 points

Question 9

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

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. | ||

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 10

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 11

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 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 7% rather than 10%. | ||

Exactly 10% of the first monthly payment represents interest. |

2 points

Question 12

Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero.

Answer

Investment A pays $250 at the beginning 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 end of every year for the next 10 years (a total of 10 payments). |

2 points

Question 13

Which of the following investments 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). |

2 points

Question 14

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 15

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 loan’s life. |

2 points

Question 16

Which of the following statements is CORRECT?

Answer

If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity. | ||

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. |

2 points

Question 17

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 18

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% A = 9.64%

AAA = 8.72% 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

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 investor’s standpoint than interest rate price risk if the investor has a short investment time horizon. |

2 points

Question 20

A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?

Answer

The bond sells at a price below par. | ||

The bond has a current yield greater than 8%. | ||

The bond sells at a discount. | ||

The bond’s required rate of return is less than 7.5%. | ||

If the yield to maturity remains constant, the price of the bond will decline over time. |

2 points

Question 21

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 22

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 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. |

2 points

Question 23

Which of the following statements is CORRECT?

Answer

All else equal, senior debt generally has a lower yield to maturity than subordinated debt. | ||

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. |

2 points

Question 24

An investor is considering buying one of two 10-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 10 years. Which of the following statements is CORRECT?

Answer

Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price. | ||

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. |

2 points

Question 25

Which of the following statements is CORRECT?

Answer

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. | ||

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. |

2 points

Question 26

Which of the following statements is CORRECT?

Answer

If the maturity risk premium were zero and interest rates were expected to decreasein 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 27

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 28

Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?

Answer

10-year, zero coupon bond. | ||

20-year, 10% coupon bond. | ||

20-year, 5% coupon bond. | ||

1-year, 10% coupon bond. | ||

20-year, zero coupon bond. |

2 points

Question 29

A 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 coupon rate exceeds its current yield. | ||

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. |

2 points

Question 30

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 bond’s expected capital gains yield is positive. | ||

The bond’s yield to maturity is 9%. | ||

The bond’s current yield is 9%. | ||

If the bond’s yield to maturity remains constant, the bond will continue to sell at par. | ||

The bond’s current yield exceeds its capital gains yield. |

2 points

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