# Questions: Department of Finance

Department of Finance

Fin331

Dr. M. Rhee

2010 Spring

NAME:

ID#:

1.If the interest is compounded quarterly with 8% APR, which of the following statements is CORRECT?

a.The periodic rate of interest is 2% and the effective rate of interest is 4%. b.The periodic rate of interest is 8% and the effective rate of interest is greater than 8%. c.The periodic rate of interest is 4% and the effective rate of interest is less than 8%. d.The periodic rate of interest is 2% and the effective rate of interest is greater than 8%. e.The periodic rate of interest is 8% and the effective rate of interest is also 8%. Answer: d

2.What is the coefficient of variation for security a?

Probability

Ra(State=?)

Rb(State=?)

Boom

35%

0.30

0.06

Average

40%

0.10

0.06

Recession

25%

--0.15

-0.05

a. 1.00

b. 1.25

c. 1.36

d. 1.73

e. 1.90

Answer: d

3.You plan to save $6,400 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. How much will you have 4 years from today?

a.$22,980.31

b.$22,685.69

c.$26,221.12

d.$29,461.93

e.$31,524.26

Answer: d

BEGIN Mode

N4Alternative setup:

I/YR5.7%01234

PV$0.00$6,400$6,400$6,400$6,400

PMT-$6,400NFV = $29,461.93

FV$29,461.93

4.Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero.

a.Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). b.Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). c.Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d.Investment D pays $2,500 at the end of 10 years (just one payment). e.Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).

Answer: a

A dominates B because it provides the same total amount, but it comes faster, hence it can earn more interest over the 10 years. A also dominates C and E for the same reason, and it dominates D because with D no interest whatever is earned. We could also do these calculations to answer the question:

FV Interest # PMT Each PMT

A$4,382.79LargestEFF%10.00%10-250

B$4,081.59NOM%9.76%-125

C$4,280.81-125

D$2,500.00-2500

E$3,984.36-250

5.Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, starting at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. For how many years can he make the $35,000 withdrawals and still have $25,000 left in the end?

a.13.48

b.14.96

c.15.71

d.16.49

e.17.32

Answer: a

6.Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes.

a.7.12%

b.7.49%

c.7.87%

d.8.26%

e.8.67%

Answer: b

N20

PV$2,550,000

PMT-$250,000

FV$0.00

I/YR7.49%

7.Which indenture provision may affect the price of the bond differently?

a.convertibility

b.sinking fund

c.call

d.restrictions on dividends

e.collateral

Answer: c

Investors do not like a call provision => they want to pay less or expect a higher return. What about other indenture provisions? All others are advantageous to investors

8.Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.80%. Assuming the pure expectations theory is correct, what is the yield on a 1-year T-bond expected to be one year from now?

a.5.61%

b.5.72%

c....

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