Deck 10: Choices Involving Time

Question 1

A ______ is a legally binding promise to make specific future payments.

A) stock
B) coupon
C) bond
D) deposit

Answer 1

bond

Question 2

Refer to Figure 10.1.Suppose the individual is initially at point b.Based on the figure,the individual could afford to increase his utility by:

A) consuming more today and less tomorrow.
B) consuming more today and more tomorrow.
C) consuming more tomorrow and less today.
D) consuming less today and less tomorrow.

Answer 2

consuming more today and less tomorrow.

Question 3

Assume the interest rate is 5%.What is the present discounted value of a $1,000 bond that pays a $50 coupon each year for 10 years?

A) $989.91
B) $999.91
C) $1,000.00
D) $1,009.99

Answer 3

$1,000.00

Question 4

Suppose you borrow $1,000 at 8% for 2 years.If the interest is compounded annually,how much money will you owe at the end of those 2 years?

A) $1,080.00
B) $1,160.00
C) $1,166.40
D) $1,345.60

Question 5

Suppose the interest rate is 6% and compounded annually.What is the present discounted value of 6 future annual payments of $150?

A) $634.46
B) $737.60
C) $849.06
D) $900.00

Question 6

If a bank is lending money at 6.25% while the government is lending money at 8.25% and the rate of inflation is 3.5%,what is the real interest being earned by the bank?

A) 2.00%
B) 2.66%
C) 2.75%
D) 6.25%

Question 7

If the real interest rate is 7.5% and the rate of inflation is 3%,what is the nominal interest rate?

A) 4.50%
B) 4.57%
C) 10.50%
D) 10.73%

Question 8

Suppose you lend $2,500 at 11.5% for 3 years.If the interest is compounded annually,how much interest will you receive in those 3 years?

A) $862.50
B) $965.49
C) $3,362.50
D) $2,465.49

Question 9

At an interest rate of 8.25% compounded annually,what is the present discounted value of $2,000 to be received 2 years from now?

A) $1670.00
B) $1706.77
C) $1716.74
D) $1835.00

Question 10

All else equal,at what interest rate would the PDV of a lottery prize that pays $1,000,000 today and $1,000,000 each year for the next 19 years be equal to $10,000,000?

A) 5.26%
B) 7.75%
C) 8.92%
D) 50.00%

Question 11

Which of following statements about bonds is NOT true?

A) Bonds have a variable term.
B) The face value of a bond is the amount to be paid at maturity.
C) The maturity of a bond refers to the period over which payments are made.
D) When interest rates rise, the present discounted value of a bond falls.

Question 12

A ______ chance of default will cause the interest rate to be ______.

A) more variable; lower
B) less variable; higher
C) higher; lower
D) higher; higher

Question 13

Given the formula PDV = $F/(1 + R)^T,the PDV is smaller when the number of years is ______ and when the interest rate is ______.

A) smaller; lower
B) smaller; higher
C) larger; lower
D) larger; higher

Question 14

All else equal,if the interest rate is 5%,what is the PDV of a lottery prize that pays $1,000,000 today and $1,000,000 each year for the next 19 years?

A) $10,500,000
B) $12,462,210
C) $13,085,321
D) $20,000,000

Question 15

The amount of money borrowed in a transaction is called:

A) interest.
B) principal.
C) internal rate of return.
D) present discounted value.

Question 16

A consumption bundle is affordable as long as:

A) it is a point that is on an indifference curve that is to the right of the budget line.
B) it is a point that falls on the 45 degree line.
C) the present discount value of the consumption stream is less than the present discount value of the income stream.
D) the amount of the good consumed from year to year does not increase.

Question 17

Which of the following statements about nominal interest and real interest is true?

A) Nominal interest is a yearly rate and real interest is a monthly rate.
B) Nominal interest does not adjust for inflation, whereas real interest does.
C) Nominal interest is what the lender receives and real interest is what the borrower pays.
D) Nominal interest and real interest are two ways of saying the same thing.

Question 18

The amount of money a lender requires for the use of funds is called:

A) interest.
B) principal.
C) internal rate of return.
D) present discounted value.

Question 19

The current worth of a claim on future resources is called:

A) net present value.
B) future value.
C) present discounted value.
D) internal rate of return.

Question 20

Which scenario has a higher present discounted value (assume interest is compounded annually); $100 received in 3 years if the interest rate is 8% or $90 received in 2 years if the interest rate is 7.25%?

A) $100 owed in 3 years
B) $90 owed in 2 years
C) Both scenarios have the same present discounted value.
D) It cannot be determined with information provided.

Question 21

Suppose a consumer's utility function is U(F₀,F₁)= F₀^0.5F₁^0.5,where F₀ represents food consumed this year and F₁ represents food consumed next year.For that utility function,the marginal utility of food consumed this year is 0.5 × (F₁/F₀)^0.5 and the marginal utility of food consumed next year is 0.5 × (F₀/F₁)^0.5.Suppose the consumer earns $100 this year and nothing in the next,food costs $1 per unit in both years,and the interest rate is 10%.How much does she spend this year,and how much does she save?

A) She spends $45 this year and saves $55.
B) She spends $50 this year and saves $50.
C) She spends $55 this year and saves $45.
D) She spends $95 this year and saves $5.

Question 22

What happens to borrowing when interest rates rise?

A) It increases.
B) It decreases.
C) It can increase or decrease.
D) Borrowing decisions are independent of interest rates.

Question 23

Which of the following is a way the government can stimulate saving?

A) Decrease interest rates
B) Increase taxes
C) Offering tax incentives for retirement accounts
D) There is nothing the government can do to stimulate saving.

Question 24

Refer to Figure 10.1.Suppose the individual is initially at point b.Based on the figure,the individual is currently:

A) a saver, which is his optimal choice.
B) a borrower, which is his optimal choice.
C) a saver, though borrowing would increase his utility.
D) a borrower, though saving would increase his utility.

Question 25

When the interest rate rises,saving becomes ______ rewarding and borrowing becomes ______ costly.

A) less; less
B) less; more
C) more; less
D) more; more

Question 26

What happens to saving when interest rates rise?

A) It increases.
B) It decreases.
C) It can increase or decrease.
D) Saving decisions are independent of interest rates.

Question 27

Refer to Figure 10.2.Which line represents saving?

A) b
B) h
C) f + i
D) d

Question 28

Which of the following is NOT used to describe an investment?

A) It is a means of saving.
B) It is a way of acquiring capital.
C) It is an up-front cost.
D) It holds the expectation of generating future profits.

Question 29

Suppose a consumer's utility function is U(F₀,F₁)= F₀^0.5F₁^0.5,where F₀ represents food consumed this year and F₁ represents food consumed next year.For that utility function,the marginal utility of food consumed this year is 0.5 × (F₁/F₀)^0.5 and the marginal utility of food consumed next year is 0.5 × (F₀/F₁)^0.5.Suppose the consumer earns $100 this year and nothing in the next,food costs $1 per unit in both years,and the interest rate is 10%.How much food does she consume this year,and how much does consume tomorrow?

A) She consumes 45 units of food this year and 55 units of food next year.
B) She consumes 50 units of food this year and 50 units of food next year.
C) She consumes 55 units of food this year and 50 units of food next year.
D) She consumes 50 units of food this year and 55 units of food next year.

Question 30

Suppose a consumer's utility function is U(F₀,F₁)= F₀^0.6F₁^0.4,where F₀ represents food consumed this year and F₁ represents food consumed next year.For that utility function,the marginal utility of food consumed this year is 0.6 × (F₁/F₀)^0.4 and the marginal utility of food consumed next year is 0.4 × (F₀/F₁)^0.6.Which of the following expressions gives the consumer's marginal rate of substitution for food this year with food next year (MRS₀₁)?

A) MRS₀₁ = F₁/F₀
B) MRS₀₁ = (2/3) × (F₀/F₁)
C) MRS₀₁ = (2/3) × (F₁/F₀)
D) MRS₀₁ = (3/2) × (F₁/F₀)

Question 31

Which of the following is NOT a reason people save?

A) To reach consumption bundles in the future that would otherwise be unattainable
B) To protect against unforeseen expenses
C) To maximize their current consumption
D) To earn additional money on unused income

Question 32

Suppose you make $1,000 investment today that you believe will have a one-time return of $2,500 in 5 years.If the interest rate is 12%,will you have a profitable investment?

A) Yes, because the NPV is positive
B) Yes, because the NPV is negative
C) No, because the NPV is positive
D) No, because the NPV is negative

Question 33

Refer to Figure 10.2.Which line represents wealth?

A) b
B) h
C) f + i
D) g

Question 34

The difference between revenue and cost during a single year of a project's life is called the:

A) interest rate.
B) net present value.
C) net cash flow.
D) profit.

Question 35

The NPV criterion states that an investment project is profitable when its NPV is ______ and unprofitable when its NPV is ______.

A) positive; positive
B) positive; negative
C) negative; positive
D) negative; negative

Question 36

The difference between the present discount value of a revenue stream and the present discount value of a cost stream is called the:

A) interest rate.
B) net present value.
C) net cash flow.
D) profit.

Question 37

Refer to Figure 10.2.For an individual that prefers a stable living standard,which line represents the best feasible consumption path?

A) a
B) b
C) c
D) h

Question 38

Which of the following are two main assumptions of The Life Cycle Hypothesis?

A) People can earn in both the first and second stages of their life. People also prefer stability in their consumption patterns.
B) People earn in the first stage of their life, but they don't earn in the second stage of their life. Interest rates are higher in the second period of a person's life than they are in the first period of a person's life.
C) People earn in the first stage of their life, but they don't earn in the second stage of their life. People also prefer stability in their consumption patterns.
D) People earn in the first stage of their life, but they don't earn in the second stage of their life. People are indifferent about the stability of their consumption patterns.

Question 39

Refer to Figure 10.2.Which line represents earnings?

A) b
B) h
C) f + i
D) d

Question 40

Which statement about the Life Cycle Hypothesis is NOT true?

A) It describes the choices of consumers who live for a long time.
B) It separates consumers' earnings into two stages.
C) It assumes that people prefer instability.
D) It assumes that people prefer a higher standard of living to a lower standard of living.

Question 41

A project is profitable when its internal rate of return is ______ the interest rate.

A) greater than
B) less than
C) equal to
D) less variable

Question 42

Table 10.1 shows the cash flows and discounted cash flows for three mutually exclusive projects available to a company.Assume an interest rate of 5%.Which project has the highest NPV?

A) Project A
B) Project B
C) Project C
D) It cannot be determined from the information given.

Question 43

You have made an investment of $250 that will yield a profit of $30 in one year.If the interest rate is 11.5% is this a good investment?

A) Yes, because the internal rate of return is greater than the interest rate
B) Yes, because the interest rate is greater than the internal rate of return
C) No, because the internal rate of return is greater than the interest rate
D) No, because the interest rate is greater than the internal rate of return

Question 44

If a project has an initial investment of $20,000 and consecutive yearly cash inflows of $5,000,$8000,$10,000 and $7,000,respectively,what is its payback period?

A) 2 years
B) 2.5 years
C) 2.7 years
D) 3 years

Question 45

Table 10.1 shows the cash flows and discounted cash flows for three mutually exclusive projects available to a company.Assume an interest rate of 5%.Which project should the company choose if they want to maximize their return?

A) Project A
B) Project B
C) Project C
D) It cannot be determined from the information given.

Question 46

Suppose you have put $5,000 into a project that should generate cash inflows of $1,250 for each of the next 5 years.If the interest rate is 8% is this a good investment?

A) Yes, because you will earn a profit of $1,250 dollars in 5 years
B) Yes, because the internal rate of return is higher than the interest rate
C) No, because the internal rate of return is higher than the interest rate
D) No, because the net present value is negative

Question 47

The rate of interest at which a project's NPV is exactly zero is called its:

A) equilibrium rate.
B) internal rate of return.
C) break-even rate.
D) zero net rate.

Question 48

Table 10.1 shows the cash flows and discounted cash flows for three mutually exclusive projects available to a company.Assume an interest rate of 5%.Which project should the company choose if they want to recover their initial investment as soon as possible?

A) Project A
B) Project B
C) Project C
D) It cannot be determined from the information given.

Question 49

Which of the following is NOT a reason why an increase in the interest rate usually makes investment projects less attractive?

A) At a higher rate, future dollars are worth less compared to current dollars.
B) A typical investment project incurs the majority of its costs early in its life.
C) A typical investment project receives a disproportionate fraction of its revenue early in its life.
D) At a higher rate, putting money into the bank is more attractive.

Question 50

What is another term for time value of money?

A) Net present value
B) Internal rate of return
C) Opportunity cost of funds
D) Yield to maturity

Question 51

The amount of time required before a project's total inflows match its total outflows is the:

A) break-even period.
B) payback period.
C) duration.
D) yield to maturity.

Question 52

Suppose the interest rate is 8%.If a project requires an initial investment of $5,000 and returns $5,500 in a year,what is its internal rate of return?

A) 2%
B) 8%
C) 10%
D) 18%

Question 53

Suppose you have put $5,000 into a project that should generate cash inflows of $1,250 for each of the next 5 years.How long will it take to recover your initial investment?

A) 3 years
B) 3.5 years
C) 4 years
D) 4.2 years

Question 54

A bond's internal rate of return is also known as its:

A) coupon.
B) payback period.
C) duration.
D) yield to maturity.

Question 55

Suppose you make a $5,000 investment that will return $3,000 in year 2 and another $3,500 in year 4.With an interest rate of 4.5%,what is the NPV of this project?

A) $247.34
B) $682.16
C) $1,500.00
D) $2,162.50

Question 56

You have made an investment of $250 that will yield a profit of $30 in one year.If the interest rate is 11.5%,what is your internal rate of return?

A) 10.7%
B) 11.8%
C) 12.0%
D) 12.2%

Question 57

Suppose you are looking to add more capacity to your current manufacturing plant.The new project will cost $6 million up front and is projected to increase revenue $1.5 million a year for each of the next 5 years.If the interest rate is 8%,what is this project's NPV and is it a profitable investment?

A) $10,935; yes it is profitable
B) -$10,935; no it is not profitable
C) $944,444; yes it is profitable
D) -$944,444; no it is not profitable

Question 58

Table 10.1 shows the cash flows and discounted cash flows for three mutually exclusive projects available to a company.Assume an interest rate of 5%.Which project has the shortest payback period?

A) Project A
B) Project B
C) Project C
D) It cannot be determined from the information given.

Question 59

Table 10.1 shows the cash flows and discounted cash flows for three mutually exclusive projects available to a company.Assume an interest rate of 5%.Which project has the highest internal rate of return?

A) Project A
B) Project B
C) Project C
D) It cannot be determined from the information given.

Question 60

When someone buys a bond,they give up the bond's price in exchange for:

A) right of ownership.
B) future income.
C) current income.
D) stock.

Question 61

Jennifer has just finished high school and is deciding whether to start working or go to college.She has already been offered a job that pays $35,000 a year.Four years of college will cost $12,000 each year.She would earn an extra $20,000 each year after she graduates for the 45 years she plans on working until she retires.Jennifer should invest in college when the net present value of that investment is ______ and the internal rate of return is ______ the current interest rate.

A) positive; greater than
B) negative; greater than
C) positive; less than
D) negative; less than

Question 62

Jennifer has just finished high school and is deciding whether to start working or go to college.She has already been offered a job that pays $35,000 a year.Four years of college will cost $12,000 each year.She would earn an extra $20,000 each year after she graduates for the 45 years she plans on working until she retires.Assume that the interest rate is 8.5%.What is Jennifer's opportunity cost of one year of college?

A) $12,000
B) $17,000
C) $35,000
D) $47,000

Question 63

Using a carefully-labeled graph,explain the Life Cycle Hypothesis.What are some of the implications of the Life Cycle Hypothesis?

Question 64

What would the interest rate need to be in order to earn $100 on an investment of $1,000 over two years? Assume interest compounds annually.

Question 65

Joe has just retired and would like to convert some of his savings into an annuity that will pay him an equal amount each year for the next 5 years.If the current interest rate is 5.75%,how much money will he have to invest in order to receive $30,000 a year?

Question 66

Jennifer has just finished high school and is deciding whether to start working or go to college.She has already been offered a job that pays $35,000 a year.Four years of college will cost $12,000 each year.She would earn an extra $20,000 each year after she graduates for the 45 years she plans on working until she retires.Assume that the interest rate is 8.5%.What is the net present value of the decision to invest in college?

A) $136,877
B) $126,154
C) $12,487
D) $11,508

Question 67

Suppose you use the rate of inflation as the interest rate for determining the present value of $1.What would the present value of $3,000 received in three equal yearly payments be if the current rate of inflation is 3.5% and increases by 15 basis points each year?

Question 68

If you were to invest $10,000 for two years and the interest rates for each of those years are 4.5% and 4.65% respectively,how much interest would you earn from the end of year one until the end of year two? Assume interest compounds annually.

Question 69

Suppose you invest $5,000 for 5 years.The interest rate for the first 2 years is 4.7%,5.2% for year 3 and 5.4% for the final 2 years.Assuming interest compounds annually,what would your investment have returned in those 5 years?

Question 70

The Table 10.2 below shows net cash flows for 3 mutually exclusive projects from which a company can choose.Each project requires an investment in the first year,then produces a positive net cash flow for each of the following four years.Assuming an interest rate of 5%,which project would the company choose? Does the best project have the highest total net cash flow? The shortest payback period?

Question 71

Durable,marketable skills that generate higher income are also known as:

A) physical capital.
B) investment capital.
C) human capital.
D) education capital.

Question 72

Jennifer has just finished high school and is deciding whether to start working or go to college.She has already been offered a job that pays $35,000 a year.Four years of college will cost $12,000 each year.She would earn an extra $20,000 each year after she graduates for the 45 years she plans on working until she retires.Assume that the interest rate is 8.5%.Given this information,what should Jennifer do?

A) Take the job
B) Go to college
C) Take the job until the interest rate goes down and then go to college
D) It cannot be determined from the information given.