Deck 16: Interest Rates, Investments, and Capital Markets

Question 1

For a given rate of interest,the total interest you receive from lending money

A) increases with the frequency of compounding.
B) decreases with the frequency of compounding.
C) is independent of the frequency of compounding.
D) is greatest when there is no compounding.

Answer 1

A

Question 2

Suppose a person has a discount rate of zero.This implies she

A) places no value on the future.
B) places no value on the present.
C) values the present and the future equally.
D) would not lend money at any positive interest rate.

Answer 2

C

Question 3

Interest rates are positive mainly because

A) of inflation.
B) people tend to prefer the present to the future.
C) people tend to prefer the future to the present.
D) bankers are greedy.

Answer 3

B

Question 4

If you agree to a long-term loan at a specified nominal rate of interest and inflation turns out to be higher than was anticipated,

A) the nominal rate of interest falls.
B) the nominal rate of interest rises.
C) the real rate of interest falls.
D) the real rate of interest rises.

Question 5

Four banks are offering the same interest rate of 4%.Where do you invest?

A) Bank A compounds interest on a yearly basis.
B) Bank B compounds interest on a monthly basis.
C) Bank C compounds interest on a daily basis.
D) I am indifferent between banks.

Question 6

If your bank pays you 6% interest on a savings account and inflation is 2%,your approximate real rate of interest is

A) 2%.
B) 4%.
C) 8%.
D) 12%.

Question 7

If the interest rate is 10%,then $1 received one year from now is worth how much today?

A) $1.10
B) $1.00
C) $0.91
D) $0.90

Question 8

If the interest rate is 10%,then $1 today is worth how much one year from now?

A) $1.10
B) $1.00
C) $0.91
D) $0.90

Question 9

If you place $100 in a bank account that pays 6% at the end of each year,and you leave your $100 and all your interest in the bank,how much will you have in the bank at the end of 7 years with annual compounding?

A) (106)⁷
B) 7 ∗ (106)
C) 100 ∗ (1.60)⁷
D) 100 ∗ (1.06)⁷

Question 10

As the interest rate rises,the present value of a given perpetual stream of income

A) increases.
B) decreases.
C) does not change.
D) approaches infinity.

Question 11

If inflation turns out to be higher than was anticipated,

A) debtors are helped.
B) debtors are hurt.
C) debtors are neither helped nor hurt.
D) the effect on debtors cannot be predicted.

Question 12

You can put your $100 in Bank A that pays 8% at the end of the year.You can also put your $100 in Bank B that pays 4% at the end of six months and then 4% again at the end of the year.You will keep your $100 and all interest in the bank.At the end of the year

A) the total will be the same at both banks.
B) the total at Bank A will be greater.
C) the total at Bank B will be greater.
D) the total could be larger at either bank.

Question 13

If savers require a 2% return and inflation is expected to be 3%,what approximate rate will banks offer savers?

A) 1%
B) 3.2%
C) 5%
D) 6%

Question 14

If inflation is 10% and the nominal interest rate equals 16.6% the real interest rate is equal to

A) 6.6%.
B) 6%.
C) -6.6%.
D) zero.

Question 15

If you invest $500 today,and the value one year from today is $1000,then the annual interest rate must be

A) 10%.
B) 50%.
C) 100%.
D) 200%.

Question 16

You invest an amount today for four years that pays 6% annually.The bank compounds annually.At the end of the four years you will have $150.What amount must you invest today?

A) $148.81
B) $138.81
C) $128.81
D) $118.81

Question 17

You place $100 in a bank account that pays 8%.If you remove the interest you receive each year you can turn your stock into a flow of

A) $108 per year.
B) $100 per year.
C) $80 per year.
D) $8 per year.

Question 18

If an individual wins a multimillion dollar lottery and chooses to receive annual payments equaling the total prize,this person has a

A) relatively low discount rate.
B) relatively high discount rate.
C) discount rate of zero.
D) It is impossible to tell.

Question 19

If inflation turns out to be higher than was anticipated,debtors are helped because

A) the real present value of their payments increases.
B) the real present value of their payments decreases.
C) the nominal present value of their payments increases.
D) the nominal present value of their payments decreases.

Question 20

Suppose two people with the same level of income and wealth have different discount rates.Joe has a very high discount rate and Jim has a very low discount rate.Which one of the following is TRUE?

A) Joe is more likely to borrow than Jim.
B) Joe is less likely to borrow than Jim.
C) Joe and Jim will borrow the same amount.
D) Neither Joe nor Jim would be borrowers.

Question 21

If the interest rate is positive,the future value of an interest bearing investment is always larger than the present value.

Question 22

The Net Present Value approach to investment results in an investment being undertaken only if

A) its net present value is positive.
B) its net present value is zero.
C) it has positive cash flow.
D) its internal rate of return equals the rate of interest.

Question 23

A firm has to choose between projects X and Y.Project X's internal rate of return is positive.If the cash flow of project Y is discounted at project X's internal rate of return,this firm will

A) choose project X if the net present value of project Y is positive.
B) choose project X if the net present value of project Y is negative.
C) choose project Y if the net present value of project Y is positive.
D) choose project X regardless of the net present value of project Y.

Question 24

Suppose a new cost-saving device will forever generate $1,000 net savings per year to a firm.The device costs $10,000.Using the Internal Rate of Return approach,the firm will make the investment

A) definitely.
B) definitely not.
C) if the interest rate exceeds 10%.
D) if the interest rate is less than 10%.

Question 25

A firm should make an investment if the expected return is greater than

A) the marginal cost of the investment.
B) the fixed cost of the investment.
C) the opportunity cost of the investment.
D) the expected rate of inflation.

Question 26

If an asset has a present value of $50 and appreciates at an interest rate of 4%,what is the asset's future value in 47 compounding periods?

A) Approximately $400
B) Approximately $316
C) Approximately $137
D) Approximately $1143

Question 27

Suppose a new cost-saving device will generate $1,000 net savings per year to a firm.The device costs $10,000.Should the firm purchase the device?

A) Definitely.
B) Absolutely not.
C) The firm is indifferent between buying the device and not.
D) More information is required to answer.

Question 28

A firm has to decide between two projects that cost $10,000 each.Project A will provide a revenue $10,700 one year from now,while Project B will provide a revenue of $12,200 two years from now.The interest rate is 10% per year.This firm

A) chooses project A.
B) chooses project B.
C) rejects both projects.
D) is indifferent between projects A and B.

Question 29

You sign a contract to pay $1000 next year for the refrigerator you bought today.The rate of inflation is 10% and the real interest rate is 7%.Alternatively,you could pay $875 today.What should you do to save the most money?

Question 30

Jerry wishes to retire in 5 years with $1 million in his bank account.If the account pays 4% and his current balance is $500,000,how much must he deposit at the beginning of each of the next five years for his wish to come true? The amount must be the same each year.

Question 31

Individuals who lease a new car

A) have a higher discount rate than those who buy.
B) have a lower discount rate than those who buy.
C) have the same discount rate as those who buy.
D) behave irrationally and are taken advantage of by car companies.

Question 32

Interest rates are positive because inflation makes purchases more expensive in the future than today.

Question 33

If an asset has a future value of $120,a present value of $30,and an interest rate of 4%,how many periods of compounding are there?

A) 45 periods
B) 35 periods
C) 28 periods
D) 100 periods

Question 34

A major corporation hires high school students on a part-time basis.It offers a reward of $5,000 to any of its high school seniors who graduate college in four years.What is the present value of that reward to a student who just finished her junior year of high school,assuming a nominal rate of interest of 8%?

Question 35

As the interest rate increases,the present value of a future payment

A) increases.
B) decreases.
C) does not change.
D) approaches infinity.

Question 36

Suppose $100 is deposited in a bank account paying 5% compounded annually.If the interest earned is X after 5 years,then the interest earned will be 2X after 10 years.

Question 37

You won the "$1,000 per year forever" lottery.You decided to convert such prize into a lump sum payment.The interest rate is 2% per year.How much is this lump sum payment ?

A) $25,000
B) $1,000
C) $50,000
D) $365,000

Question 38

A state lottery has a Million Dollar Lottery game that pays $1,000 a week for life.Assuming a 6% nominal rate of interest and generously assuming an infinite lifetime,can this game be called a "Million Dollar Lottery"?

Question 39

In using the Internal Rate of Return approach,one must first calculate the discount rate on the investment that makes

A) the net present value equal zero.
B) the interest rate equal zero.
C) the interest rate equal the discount rate.
D) the first year's return positive.

Question 40

In an economy with no inflation,explain why interest rates are positive.

Question 41

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.Which of the following makes it less likely that Joe will decide to go back to college full-time?

A) The extra income due to a college degree rises.
B) The rate of interest decreases.
C) The government enacts mandatory retirement at age 60.
D) Tuition decreases.

Question 42

Bobby faces two choices.The first is to receive $600 on the spot.The other choice is to receive $800 a year from now.The interest rate is 5% per year.What could a possible explanation for Bobby choosing to receive $600 on the spot?

A) Bobby finds that the present value of the $800 a year from now is less than $600.
B) Bobby may have time-inconsistent preferences.
C) Although Bobby chooses $600 on the spot, he is actually indifferent between the two options.
D) None of the above is correct.

Question 43

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.His cost of going back to college is

A) 10,000 ×
B) 20,000 ×
C) 30,000 ×
D) 40,000 ×

Question 44

If a bond's coupon adjusts to pay a constant real rate of return,then an increase in inflation would cause

A) the nominal coupon payment to rise.
B) the nominal coupon payment to fall.
C) the nominal coupon payment to remain unchanged.
D) the bond's price to fluctuate wildly.

Question 45

Today John says: "I will start working out tomorrow." Yet,as tomorrow arrives he doesn't.This is an example of

A) time inconsistent preferences.
B) time consistent preferences.
C) exponential discounting.
D) future-biased preferences.

Question 46

Assume a baseball player's development in the minor leagues yields -$250,000 per year for four years.If the player were to have a single big league season and be paid $350,000,how much revenue would the player need to generate to be considered a positive net present value project from the point of view of the team owner if the interest rate was 4%?

A) $1.45 million
B) $2.5 million
C) $350,000
D) $250,000

Question 47

A bond issuer agrees to pay a stated nominal amount each year.An increase in the nominal interest rate will cause

A) the price of the bond to fall.
B) the price of the bond to rise.
C) the nominal value of the bond's coupon to rise.
D) the nominal value of the bond's coupon to fall.

Question 48

A recent purchaser of a bond that agrees to pay an annual nominal amount would hope that interest rates do not rise.

Question 49

The question "What are you going to do with that major?" implicitly questions

A) how much you learn in that major.
B) whether the major should be offered on campus.
C) how much the market values the human capital developed in the major.
D) western bias.

Question 50

To calculate the internal rate of return on a factory that would yield a perpetual future stream of income,one would divide

A) the annual future payment by the cost of the factory.
B) the sum of the future payments by the cost of the factory.
C) the cost of the factory by the rate of interest.
D) the cost of the factory by the annual future payment.

Question 51

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.His benefit of a degree would be

A) 10,000 ×
B) 10,000 × .
C) 10,000/r.
D) 10,000 ×

Question 52

With respect to events like global warming some economists suggest using falling discount rates because

A) exponential discounting virtually gives no weight to (large) costs incurred far into the future.
B) exponential discounting weights (large) costs incurred far into the future heavily.
C) events far in the future do not affect us.
D) we should not care about costs far in the future.

Question 53

Billy is considering the purchase of a rental house.The house costs $240,000 and it will generate annual revenues of $15,000 and annual expenses of $3,000.Nevertheless,Billy will need to borrow $240,000 at an interest rate of 7% per year in case he decides to make this investment.Should Billy purchase this house?

A) No, he will lose money.
B) Yes, his profits will be zero.
C) No, his profits will be positive but close to zero.
D) Yes, he will profit from this investment.

Question 54

Billy is considering the purchase of a rental house.The house costs $240,000 and it will generate annual revenues of $15,000 and annual expenses of $3,000.What is the internal rate of return of this investment?

A) 5%
B) 7.5%
C) 3.75%
D) 24%

Question 55

If a firm needs one machine to produce a product,and must replace the machine when it wears out,then the firm should pick a durability level of the machine that

A) minimizes the expense today.
B) minimizes the present discounted cost of having the machine forever.
C) maximizes the future value of the machine.
D) minimizes the future value of the machine.

Question 56

Using the Internal Rate of Return approach to investment,one would undertake an investment if the internal rate of return

A) equals zero.
B) equals the interest rate.
C) exceeds the interest rate.
D) is less than the interest rate.

Question 57

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.Which of the following makes it more likely that Joe will decide to go back to college full-time?

A) The rate of interest increases.
B) The rate of interest decreases.
C) The government enacts mandatory retirement at age 60.
D) Tuition increases.

Question 58

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.If these are real amounts (adjusted for inflation),then the discount rate to be used should be

A) the nominal rate of interest.
B) the real rate of interest.
C) the rate of inflation.
D) zero.

Question 59

An individual who wants to stop smoking but chooses not to

A) reflects future bias.
B) reflects present bias.
C) reflects irrationality.
D) reflects uncontrollable addiction.

Question 60

At age 40,Joe is considering quitting his job and going back for a college degree.He needs two more years full-time.Tuition is $10,000 per year.He earns $30,000 per year.A college degree would raise his annual income by $10,000 per year.He will retire at age 70.From an investment standpoint,Joe will go back full-time if

A) 10,000 × = 40,000 ×

B) 10,000/r > 10,000 ×
C) 10,000 × > 40,000 ×

D) 10,000 × > 40,000 ×

Question 61

If a non-renewable resource is scarce,has constant marginal cost of production and is sold in a competitive market,

A) its price will increase over time.
B) its price will exceed marginal cost.
C) its price will increase by the rate of interest.
D) All of the above.

Question 62

Consider a wine maker who has put her wine in bottles.The question is whether to store the wine for a marginal cost of $1 per year or to sell the wine today at a price of $10.If the interest rate is 6%,how much must the price of the wine increase in the next year to justify storing it?

A) $1.66
B) $1.27
C) $0.72
D) $0.45

Question 63

An exhaustible resource with a very large known reserve will most likely exhibit

A) a highly variable price in the near future.
B) a decreasing price in the near future.
C) an increasing price in the near future.
D) a constant price in the near future.

Question 64

Suppose we know that 10 Spanish Galleons sunk in the Atlantic ocean carrying approximately 50 tons of gold,but the exact location of these shipwrecks is unknown.Would this gold add to the world reserve?

A) Yes, we know it exists.
B) No, we know it exists but we can't extract the gold.
C) Yes, it's only a matter of time before the shipwrecks are discovered.
D) No, there are no established property rights over the shipwreck so they cannot add to world reserves..

Question 65

In reality,prices of non-renewable resources have not increased continually according to the model developed in Section 16.3 because of

A) abundance of the resource.
B) technological progress changing marginal cost.
C) changing market power of producers.
D) All of the above.

Question 66

The spread between price and marginal cost of an exhaustible resource must grow by the rate of interest so that

A) resource owners earn a profit.
B) resource owners are willing to sell some of the resource in the future.
C) the price of the resource remains constant in real terms.
D) the marginal cost of extracting the resource declines.

Question 67

You grow poplar trees.The lumber yard purchases cut trees from you.The trees grow 1 foot per year.Assuming a constant real price per foot for poplar and a real interest rate of 3%,would you sell a 20-foot tree today?

Question 68

In the later part of the twentieth century,the price of crude oil began to increase after decades of relatively steady prices,which of the following could explain this phenomenon?

A) Worldwide reserves have been increasing.
B) Worldwide demand has been increasing.
C) Global warming
D) Extraction technology has been degrading.

Question 69

Suppose that your college offers you two payment plans.You may either pay tuition of $10,000 per year at the beginning of each of the next four years,or pay just $38,000 before the start of freshman year.If the interest rate is 10%,what would you do? If the interest rate were 2%,what would you do? Intuitively explain the difference in your answer.

Question 70

Suppose that your college offers you two payment plans for your last two years of college.You may either pay tuition of $20,000 per year at the beginning of each of the next two years,or pay just $38,000 before the start of freshman year.What would the interest rate have to be for you to be indifferent between these two deals? Explain.

Question 71

If an exhaustible resource is scarce,has constant marginal cost over time,and is sold in a competitive market,then

A) its price increases over time.
B) its price will not be a function of the interest rate.
C) its price moves independently of past prices.
D) its price equals marginal cost.

Question 72

A financial services company offers to pay you $1,000 a year for life in exchange for $20,000 today.What factors affect your decision to take this offer?

Question 73

Suppose an exhaustible resource can be sold only this period or next period.The resource owner is considering selling 100 tons of the resource this period.The future value of the resource when 100 tons are sold this period is less than the present value of the 100 tons sold this period multiplied by one plus the interest rate.What should the resource owner do?

A) She should sell more than 100 tons this period.
B) She should sell only 100 tons this period.
C) She should sell less than 100 tons this period.
D) She should not sell any of the resource in either period.

Question 74

Explain why a firm may rationally make an investment when its cash flow from the investment is not positive each year.

Question 75

If an exhaustible resource is priced at marginal cost that remains constant over time,then

A) all owners of that resource earn rent.
B) the price will stay constant over time.
C) the percent price increase each year equals the rate of interest.
D) the good is relatively scarce.

Question 76

What is the internal rate of return on a new $2,000 heater that would reduce your heating costs by $200 a year forever? Under what conditions would you make the purchase?

Question 77

Technological improvements in coal mining will

A) increase the price of coal.
B) decrease the price of coal.
C) increase the interest rate.
D) decrease the interest rate.

Question 78

An investment is profitable as long as its internal rate of return is equal to the rate of interest.

Question 79

The growth over time in the spread between price and marginal cost of an exhaustible resource is equal to

A) zero.
B) one.
C) the interest rate.
D) the present value of the reserves.

Question 80

If extraction technology continues to improve over time,

A) the price of crude oil can continue to fall or stay steady.
B) the price of crude oil will increase despite any attempts to stem demand.
C) the price of crude oil will only fall if sufficient government taxation is implemented.
D) the price of crude oil will only fall if sufficient demand declines are arranged.