Exam 5: The Value of Money

Your Aunt Ruth has $500,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. How many years will it take to exhaust her funds, i.e., run the account down to zero?

You want to buy a new ski boat 2 years from now, and you plan to save $8,200 per year, beginning one year from today. You will deposit your savings in an account that pays 6.2% interest. How much will you have just after you make the 2nd deposit, 2 years from now?

Suppose you have $2,000 and plan to purchase a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. How much will you have when the CD matures?

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.

The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant.

When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years.

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan).

Janice has $5,000 invested in a bank that pays 3.8% annually. How long will it take for her funds to triple?

All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price?

What's the future value of $1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?

What's the present value of $4,500 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually?

Which of the following statements is CORRECT?

Suppose a State of California bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.5%, how much is the bond worth today?

You are negotiating to make a 7-year loan of $25,000 to Breck Inc. To repay you, Breck will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. Breck is essentially riskless, so you are confident the payments will be made. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?

Starting to invest early for retirement reduces the benefits of compound interest.

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

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

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.