Problem Sets 15 401 08

MIT Sloan Finance Problems and Solutions Collection
Finance Theory I
Part 1
Andrew W. Lo and Jiang Wang
Fall 2008
(For Course Use Only. All Rights Reserved.)

Acknowledgements
The problems in this collection are drawn from problem sets and exams used in Finance
Theory I at Sloan over the years. They are created by many instructors of the course, including (but not limited to) Utpal Bhattacharya, Leonid Kogan, Gustavo Manso, Stew
Myers, Anna Pavlova, Dimitri Vayanos and Jiang Wang.

Contents
1 Present Value

1

2 Fixed Income Securities

9

3 Common Stock

28

1 Present Value Solutions

36

2 Fixed Income Securities Solutions

43

3 Common Stock Solutions

58

1

Present Value
1. You can invest $10,000 in a certificate of deposit (CD) offered by your bank. The CD is for 5 years and the bank quotes you a rate of 4.5%. How much will you have in 5 years if the 4.5% is
(a) an EAR?
(b) a quarterly APR?
(c) a monthly APR?
2. (W) e-Money rates. An internet company, e-Money, is offering a money market account with an A.P.R. of 4.75%. What is the effective annual interest rate offered by e-Money if the compounding interval is
(a) annual
(b) monthly
(c) weekly
(d) continuously?
3. You can invest $50,000 in a certificate of deposit (CD) offered by your bank. The CD is for 2 years and the bank quotes you a rate of 4%. How much will you have in 2 years if the 4% is
(a) an EAR?
(b) a quarterly APR?
(c) a monthly APR?
4. You can invest $10,000 in a certificate of deposit (CD) offered by your bank. The CD is for 5 years and the bank quotes you a rate of 4.5%. How much will you have in 5 years if the 4.5% is
(a) an EAR?
(b) a quarterly APR?
(c) a monthly APR?
5. e-Money rates. An internet company, e-Money, is offering a money market account with an A.P.R. of 5.25%. What is the effective annual interest rate offered by e-Money if the compounding interval is
(a) annual
(b) monthly
(c) daily

Fall 2008

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(d) continuously?
6. True, false or “it depends” (give a brief