Question 1

Suppose that Ray Allen, a basketball player for the Seattle Supersonics, will become a free agent at the end of this NBA season.Suppose that Allen is considering two possible contracts from different teams.Note that the salaries are paid at the end of EACH year. $\begin{array}{lll} 
& \text { Contract \#1 (Seattle) } & \text { Contract \#2 (Portland) } \
\text { Signing bonus (paid today) } & \$ 1 \text { million } & \$ 1 \text { million } \
\text { First-year salary } & \$ 2 \text { million } & \$ 4 \text { million } \
\text { Second-year salary } & \$ 4 \text { million } & \$ 4 \text { million } \
\text { Third-year salary } & \$ 5 \text { million } & \$ 3 \text { million }
\end{array}$ The interest rate is 10%.Based on this information, which of the following is true?

Accepted Answer

A)  Allen should take the Seattle contract because it has a higher present value
B)  Allen should take the Portland contract because it has a higher present value
C)  Allen is indifferent between the two contracts because they are both worth $12 million
D)  Allen is indifferent between the two contracts because they are both worth $10.9 million  A

Question 2

Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.

Accepted Answer

It is almost impossible to quote real interest rates ex ante.For any given nominal interest rate, the real interest rate is the nominal interest rate less the rate of inflation.The problem is no one knows what the rate of inflation will be exactly.As a result it is easier to quote nominal interest rates.

Question 3

You win your state lottery.The lottery officials offer you the following options: you can accept annual payments of $50,000 for 20 years or receive an upfront payment of $700,000.Ignoring issues like mortality tables, taxes, etc., what market interest rate would make it more attractive to take the upfront payment?

Accepted Answer

Using a financial calculator or a spreadsheet we can equate the $700,000 to the sum of the present value flow of receiving $50,000 a year for the next 20 years, and the internal rate of return is 3.67%.If you are confident that you can earn an average annual return greater than 3.67% a year over the next 20 years, the upfront payment may be the option to select.

Question 4

From the Fisher equation we see that the nominal interest rate and expected inflation have:

Accepted Answer

A)  An inverse relationship
B)   HYPERLINK "" Error! Hyperlink reference not valid.HYPERLINK "" Error! Hyperlink reference not valid.direct but less than one-to-one
C)  A relationship which is direct and one-to-one
D)  No relationship

Question 5

Which of the following statements is most correct?

Accepted Answer

A)  We can always compute the ex post real interest rate but not the ex ante real rate
B)  We cannot compute either the ex post or ex ante real interest rates accurately
C)  We can accurately compute the ex ante real interest rate but not the ex post real rate
D)  None of the above statements is correct

Question 6

The future value of $100 that earns 10% annually for n years is best expressed by which of the following?

Accepted Answer

A)  $100(0.1) n
B)  $100 x n x (1.1) 
C)  $100(1.1) n
D)  $100/(1.1) n

Question 7

A monthly growth rate of 0.6% is an annual growth rate of:

Accepted Answer

A)  7.20%
B)  6.00%
C)  7.60%
D)  7.44%

Question 8

A bond offers a $50 coupon, has a face value of $1,000, and has 10 years to maturity.If the interest rate is 4.0% what is the value of this bond?

Accepted Answer

The answer of A bond offers a $50 coupon, has...

Question 9

Explain why an investor cannot simply compare the size of promised payments from different investments, even if the interest rates and other risk factors are the same.

Accepted Answer

The answer of Explain why an investor cannot simply compare...

Question 10

Suppose Mary receives an $8,000 loan from First National Bank.Mary repays $8,480 to First National Bank at the end of one year.Assuming the simple calculation of interest, the interest rate on Mary's loan was:

Accepted Answer

A)  8.00%
B)  $480
C)  6.00%
D)  5.66%

Question 11

Which formula below best expresses the real interest rate, (r)?

Accepted Answer

A)  i = r - π\piπ e
B)  r = i +  π\piπ e
C)  r = i -  π\piπ e
D)   π\piπ e = i + r

Question 12

The interest rate used to discount the promised payment from a bond:

Accepted Answer

A)  Will vary directly with the value of the bond
B)  Should be the one that makes the value equal to the par value of the bond
C)  Will vary inversely with the value of the bond
D)  Should always be greater than the coupon rate

Question 13

An investment carrying a current cost of $120,000 is going to generate $50,000 of revenue for each of the next three years.To calculate the internal rate of return we need to:

Accepted Answer

A)  Calculate the present value of each of the $50,000 payments and multiply these and set this equal to $120,000
B)  Find the interest rate at which the present value of $150,000 for three years from now equals $120,000
C)  Find the interest rate at which the sum of the present values of $50,000 for each of the next three years equals $120,000
D)  Subtract $120,000 from $150,000 and set this difference equal to the interest rate

Question 14

What is the present value of $100 promised one year from now at 10% annual interest?

Accepted Answer

A)  $89.50
B)  $90.00
C)  $90.91
D)  $91.25

Question 15

The future value of $200 that is left in account earning 6.5% interest for three years is best expressed by which of the following?

Accepted Answer

A)  $200(1.065)  x 3
B)  $200(1.065) /3
C)  $200(1.065) n
D)  $200(1.065) 3

Question 16

The price of a coupon bond is determined by:

Accepted Answer

A)  Taking the present value of the bond's final payment and subtracting the coupon payments
B)  Taking the present value of the coupon payments and adding this to the face value
C)  Taking the present value of the bond's final payment
D)  Taking the present value of all of the bond's payments

Question 17

According to the rule of 72:

Accepted Answer

A)  Any amount should double in value in 72 months if invested at 10%
B)  72/interest rate is the number of years approximately it will take for an amount to double
C)  72 x interest rate is the number of years it will take for an amount to double
D)  The interest rate divided by the number of years invested will always equal 72%

Question 18

A mortgage, where the monthly payments are the same for the duration of the loan, is an example of:

Accepted Answer

A)  A variable payment loan
B)  An installment loan
C)  A fixed payment loan
D)  An equity security

Question 19

Suppose a two-year coupon bond has payments of $40 and a face value of $800.The interest rate is 8%.Compute the present value of the coupon payments and the principal payment of the bond.What is the price of this bond?

Accepted Answer

The answer of Suppose a two-year coupon bond has payments...

Question 20

How might the behavior of professional investment managers prior to the financial crisis of 2007-2009 contributed to the depth of the plunge of corporate and mortgage security prices during the crisis?

Accepted Answer

The answer of How might the behavior of professional investment...

Exam 4: Future Value, Present Value, and Interest Rates