# Investment and Effective Annual Rate

Financial Management

Prof. S.J. Kim

BIZ2119-07

Fall, 2012

1. What is the difference between accounting income and cash flow? Which do we need to use when making decisions?

2. Why is there a difference between the interest rates on AAA corporate bonds and U.S. Treasury notes?

3. Your father is about to retire. His firm has given him the option of retiring with a lump sum of $50,000 in ten years or an annuity of $8,000 for ten years. Which is worth more now, if the discount rate is (a) 6% (b) 19%?

4. Suppose you open a saving account with $1,800 earned in a summer job. The account's stated interest rate is 11%. Calculate effective annual rate (EAR) if interest is paid (a) semiannually, (b) quarterly, (c) monthly and (d) daily. 5. You can buy a security at a price of $10,250. If you buy the security, you will receive five annual payments of $2,500, the first payment to be made one year from today. What rate of return, or yield, does the security offer? 6. A bank agrees to lend you $1,000 today in return for your promise to pay the bank $1,419 six years from today. What rate of interest is the bank charging you? 7. How long will it take to double your money with a growth rate of (a) 10 percent? (b) 20 percent? (c) 40 percent? (d) What about tenfold increase in your money with a growth rate of 50 percent?

8. Suppose you assume a mortgage of $300,000. The terms of the mortgage are the following: thirty year mortgage with equal monthly installments, the first installment to be paid one month from now. The current annual mortgage rate is 9% compounded monthly.

(a) What is the effective annual rate(EAR) on the mortgage?

(b) What is the monthly payment on the mortgage?

Take the same mortgage except for the fact that you have to repay the mortgage in equal annual installments, with the first installment to be paid one year from today.

(c) Assuming that the mortgage rate of 9% is annually compounded, compute the annual payment on the...

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