Strayer FIN534 Week 4 Quiz 3

FIN 534 Week 4 Quiz 3
Question 1
You are considering two equally risky annuities, each of which
pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred)
annuity, while Investment DUE is an annuity due. Which of the following
statements is CORRECT?
Answer
The present value of ORD must exceed the present value of DUE, but
the future value of ORD may be less than the future value of DUE.
The present value of DUE exceeds the present value of ORD, while
the future value of DUE is less than the future value of ORD.
The present value of ORD exceeds the present value of DUE, and the
future value of ORD also exceeds the future value of DUE.
The present value of DUE exceeds the present value of ORD, and the
future value of DUE also exceeds the future value of ORD.
If the going rate of interest decreases from 10% to 0%, the
difference between the present value of ORD and the present value of DUE would
remain constant.
2 points
Question 2
A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years
from today. The nominal interest rate is 6%, semiannual compounding. Which of
the following statements is CORRECT?
Answer
The periodic interest rate is greater than 3%.
The periodic rate is less than 3%.
The present value would be greater if the lump sum were discounted
back for more periods.
The present value of the $1,000 would be larger if interest were
compounded monthly rather than semiannually.
The PV of the $1,000 lump sum has a smaller present value than the
PV of a 3-year, $333.33 ordinary annuity.
2 points
Question 3
Which of the following statements is CORRECT?
Answer
A time line is not meaningful unless all cash flows occur
annually.
Time lines are useful for visualizing complex problems prior to
doing actual calculations.
Time lines cannot be constructed in situations where some of the
cash flows occur annually but others occur quarterly.
Time lines cannot be constructed for annuities where the payments
occur at the beginning of the periods.
Some of the cash flows shown on a time line can be in the form of
annuity payments, but none can be uneven amounts.
2 points
Question 4
Which of the following statements is CORRECT?
Answer
The present value of a 3-year, $150 ordinary annuity will exceed
the present value of a 3-year, $150 annuity due.
If a loan has a nominal annual rate of 8%, then the effective rate
will never be less than 8%.
If a loan or investment has annual payments, then the effective,
periodic, and nominal rates of interest will all be different.
The proportion of the payment that goes toward interest on a fully
amortized loan increases over time.
An investment that has a nominal rate of 6% with semiannual
payments will have an effective rate that is smaller than 6%.
2 points
Question 5
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.
Answer
Investment A pays $250 at the beginning of every year for the next
10 years (a total of 10 payments).
Investment B pays $125 at the end of every 6-month period for the
next 10 years (a total of 20 payments).
Investment C pays $125 at the beginning of every 6-month period
for the next 10 years (a total of 20 payments).
Investment D pays $2,500 at the end of 10 years (just one
payment).
Investment E pays $250 at the end of every year for the next 10
years (a total of 10 payments).
2 points
Question 6
Which of the following statements is CORRECT?
Answer
If you have a series of cash flows, each of which is positive, you
can solve for I, where the solution value of I causes the PV of the cash flows
to equal the cash flow at Time 0.
If you have a series of cash flows, and CF0 is negative but each
of the following CFs is positive, you can solve for I, but only if the sum of
the undiscounted cash flows exceeds the cost.
To solve for I, one must identify the value of I that causes the
PV of the positive CFs to equal the absolute value of the FV of the negative
CFs. It is impossible to find the value of I without a computer or financial
calculator.
If you solve for I and get a negative number, then you must have
made a mistake.
If CF0
is positive and all the other CFs are negative, then you can still solve for I.
2 points
Question 7
Which of the following investments would have the lowest present
value? Assume that the effective annual rate for all investments is the same
and is greater than zero.
Answer
Investment A pays $250 at the end of every year for the next 10
years (a total of 10 payments).
Investment B pays $125 at the end of every 6-month period for the
next 10 years (a total of 20 payments).
Investment C pays $125 at the beginning of every 6-month period
for the next 10 years (a total of 20 payments).
Investment D pays $2,500 at the end of 10 years (just one
payment).
Investment E pays $250 at the beginning of every year for the next
10 years (a total of 10 payments).
2 points
Question 8
You plan to analyze the value of a potential investment by
calculating the sum of the present values of its expected cash flows. Which of
the following would increase the calculated value of the investment?
Answer
The cash flows are in the form of a deferred annuity, and they
total to $100,000. You learn that the annuity lasts for 10 years rather than 5
years, hence that each payment is for $10,000 rather than for $20,000.
The discount rate decreases.
The riskiness of the investment’s cash flows increases.
The total amount of cash flows remains the same, but more of the
cash flows are received in the later years and less are received in the earlier
years.
The discount rate increases.
2 points
Question 9
Which of the following statements regarding a 15-year (180-month)
$125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
Answer
The remaining balance after three years will be $125,000 less one
third of the interest paid during the first three years.
Because the outstanding balance declines over time, the monthly
payments will also decline over time.
Interest payments on the mortgage will increase steadily over
time, but the total amount of each payment will remain constant.
The proportion of the monthly payment that goes towards repayment
of principal will be lower 10 years from now than it will be the first year.
The outstanding balance declines at a faster rate in the later
years of the loan’s life.
2 points
Question 10
Which of the following statements is CORRECT?
Answer
The present value of a 3-year, $150 annuity due will exceed the
present value of a 3-year, $150 ordinary annuity.
If a loan has a nominal annual rate of 8%, then the effective rate
can never be greater than 8%.
If a loan or investment has annual payments, then the effective,
periodic, and nominal rates of interest will all be different.
The proportion of the payment that goes toward interest on a fully
amortized loan increases over time.
An investment that has a nominal rate of 6% with semiannual
payments will have an effective rate that is smaller than 6%.
2 points
Question 11
Which of the following statements is CORRECT?
Answer
The cash flows for an ordinary (or deferred) annuity all occur at
the beginning of the periods.
If a series of unequal cash flows occurs at regular intervals,
such as once a year, then the series is by definition an annuity.
The cash flows for an annuity due must all occur at the ends of
the periods.
The cash flows for an annuity must all be equal, and they must
occur at regular intervals, such as once a year or once a month.
If some cash flows occur at the beginning
of the periods while others occur at the ends, then we have what the textbook
defines as a variable annuity.
2 points
Question 12
Your bank account pays an 8% nominal rate of interest. The
interest is compounded quarterly. Which of the following statements is CORRECT?
Answer
The periodic rate of interest is 2% and the effective
rate of interest is 4%.
The periodic rate of interest is 8% and the effective
rate of interest is greater than 8%.
The periodic rate of interest is 4% and the effective
rate of interest is less than 8%.
The periodic rate of interest is 2% and the effective
rate of interest is greater than 8%.
The periodic rate of interest is 8% and the effective
rate of interest is also 8%.
2 points
Question 13
You plan to invest some money in a bank account. Which of the
following banks provides you with the highest effective rate of interest?
Answer
Bank 1; 6.1% with annual compounding.
Bank 2; 6.0% with monthly compounding.
Bank 3; 6.0% with annual compounding.
Bank 4; 6.0% with quarterly compounding.
Bank 5; 6.0% with daily (365-day) compounding.
2 points
Question 14
Which of the following statements regarding a 15-year (180-month)
$125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions
costs.)
Answer
The remaining balance after three years will be $125,000 less one
third of the interest paid during the first three years.
Because it is a fixed-rate mortgage, the monthly loan payments
(which include both interest and principal payments) are constant.
Interest payments on the mortgage will increase steadily over
time, but the total amount of each payment will remain constant.
The proportion of the monthly payment that goes towards repayment
of principal will be lower 10 years from now than it will be the first year.
The outstanding balance declines at a slower rate in the later
years of the loan’s life.
2 points
Question 15
Which of the following statements regarding a 30-year monthly
payment amortized mortgage with a nominal interest rate of 10% is CORRECT?
Answer
The monthly payments will decline over time.
A smaller proportion of the last monthly payment will be interest,
and a larger proportion will be principal, than for the first monthly payment.
The total dollar amount of principal being paid off each month
gets smaller as the loan approaches maturity.
The amount representing interest in the first payment would be
higher if the nominal interest rate were 7% rather than 10%.
Exactly 10% of the first monthly payment represents interest.
2 points
Question 16
A 12-year bond has an annual coupon rate of 9%. The coupon rate
will remain fixed until the bond matures. The bond has a yield to maturity of
7%. Which of the following statements is CORRECT?
Answer
If market interest rates decline, the price of the bond will also
decline.
The bond is currently selling at a price below its par value.
If market interest rates remain unchanged, the bond’s price one
year from now will be lower than it is today.
The bond should currently be selling at its par value.
If market interest rates remain unchanged, the bond’s price one
year from now will be higher than it is today.
2 points
Question 17
Which of the following statements is NOT CORRECT?
Answer
If a bond is selling at a discount to par, its current yield will
be less than its yield to maturity.
All else equal, bonds with longer maturities have more interest
rate (price) risk than bonds with shorter maturities.
If a bond is selling at its par value, its current yield equals
its yield to maturity.
If a bond is selling at a premium, its current yield will be
greater than its yield to maturity.
All else equal, bonds with larger coupons have greater interest
rate (price) risk than bonds with smaller coupons.
2 points
Question 18
A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury
bond has a 10% coupon. Both bonds have the same yield to maturity. If the yield
to maturity of both bonds increases by the same amount, which of the following
statements would be CORRECT?
Answer
The prices of both bonds will decrease by the same amount.
Both bonds would decline in price, but the 10-year bond would have
the greater percentage decline in price.
The prices of both bonds would increase by the same amount.
One bond’s price would increase, while the other bond’s price
would decrease.
The prices of the two bonds would remain constant.
2 points
Question 19
Which of the following statements is CORRECT?
Answer
All else equal, high-coupon bonds have less reinvestment rate risk
than low-coupon bonds.
All else equal, long-term bonds have less interest rate price risk
than short-term bonds.
All else equal, low-coupon bonds have less interest rate price
risk than high-coupon bonds.
All else equal, short-term bonds have less reinvestment rate risk
than long-term bonds.
All else equal, long-term bonds have less reinvestment rate risk
than short-term bonds.
2 points
Question 20
An investor is considering buying one of two 10-year, $1,000 face
value bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual
coupon. Both bonds have a yield to maturity of 8%, which is expected to remain
constant for the next 10 years. Which of the following statements is CORRECT?
Answer
Bond B has a higher price than Bond A today, but one year from now
the bonds will have the same price.
One year from now, Bond A’s price will be higher than it is today.
Bond A’s current yield is greater than 8%.
Bond A has a higher price than Bond B today, but one year from now
the bonds will have the same price.
Both bonds have the same price today, and the price of each bond
is expected to remain constant until the bonds mature.
2 points
Question 21
Which of the following statements is CORRECT?
Answer
If the maturity risk premium were zero and interest rates were
expected to decrease
in the future, then the yield curve for U.S. Treasury securities would, other
things held constant, have an upward slope.
Liquidity premiums are generally higher on Treasury than corporate
bonds.
The maturity premiums embedded in the interest rates on U.S.
Treasury securities are due primarily to the fact that the probability of
default is higher on long-term bonds than on short-term bonds.
Default risk premiums are generally lower on corporate than on
Treasury bonds.
Reinvestment rate risk is lower, other things held constant, on
long-term than on short-term bonds.
2 points
Question 22
Which of the following statements is CORRECT?
Answer
A zero coupon bond’s current yield is equal to its yield to
maturity.
If a bond’s yield to maturity exceeds its coupon rate, the bond
will sell at par.
All else equal, if a bond’s yield to maturity increases, its price
will fall.
If a bond’s yield to maturity exceeds its coupon rate, the bond
will sell at a premium over par.
All else equal, if a bond’s yield to maturity increases, its
current yield will fall.
2 points
Question 23
Which of the following statements is CORRECT?
Answer
Sinking fund provisions sometimes turn out to adversely affect
bondholders, and this is most likely to occur if interest rates decline after
the bond has been issued.
Most sinking funds require the issuer to provide funds to a
trustee, who saves the money so that it will be available to pay off
bondholders when the bonds mature.
A sinking fund provision makes a bond more risky to investors at
the time of issuance.
Sinking fund provisions never require companies to retire their
debt; they only establish “targets” for the company to reduce its debt over
time.
If interest rates have increased since a company issued bonds with
a sinking fund, the company is less likely to retire the bonds by buying them
back in the open market, as opposed to calling them in at the sinking fund call
price.
2 points
Question 24
A 10-year bond with a 9% annual coupon has a yield to maturity of
8%. Which of the following statements is CORRECT?
Answer
If the yield to maturity remains constant, the bond’s price one
year from now will be higher than its current price.
The bond is selling below its par value.
The bond is selling at a discount.
If the yield to maturity remains constant, the bond’s price one
year from now will be lower than its current price.
The bond’s current yield is greater than 9%.
2 points
Question 25
You are considering two bonds. Bond A has a 9% annual coupon while
Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the
YTM is expected to remain constant. Which of the following statements is
CORRECT?
Answer
The price of Bond B will decrease over time, but the price of Bond
A will increase over time.
The prices of both bonds will remain unchanged.
The price of Bond A will decrease over time, but the price of Bond
B will increase over time.
The prices of both bonds will increase by 7% per year.
The prices of both bonds will increase over time, but the price of
Bond A will increase by more.
2 points
Question 26
If its yield to maturity declined by 1%, which of the following
bonds would have the largest percentage increase in value?
Answer
A 1-year zero coupon bond.
A 1-year bond with an 8% coupon.
A 10-year bond with an 8% coupon.
A 10-year bond with a 12% coupon.
A 10-year zero coupon bond.
2 points
Question 27
Under normal conditions, which of the following would be most
likely to increase
the coupon rate required to enable a bond to be issued at par?
Answer
Adding additional restrictive covenants that limit management’s
actions.
Adding a call provision.
The rating agencies change the bond’s rating from Baa to Aaa.
Making the bond a first mortgage bond rather than a debenture.
Adding a sinking fund.
2 points
Question 28
Which of the following statements is CORRECT?
Answer
If the Federal Reserve unexpectedly announces that it expects
inflation to increase, then we would probably observe an immediate increase in
bond prices.
The total yield on a bond is derived from dividends plus changes
in the price of the bond.
Bonds are riskier than common stocks and therefore have higher
required returns.
Bonds issued by larger companies always have lower yields to
maturity (less risk) than bonds issued by smaller companies.
The market value of a bond will always approach its par value as
its maturity date approaches, provided the bond’s required return remains
constant.
2 points
Question 29
Which of the following statements is CORRECT?
Answer
All else equal, senior debt generally has a lower yield to
maturity than subordinated debt.
An indenture is a bond that is less risky than a mortgage bond.
The expected return on a corporate bond will generally exceed the
bond’s yield to maturity.
If a bond’s coupon rate exceeds its yield to maturity, then its
expected return to investors exceeds the yield to maturity.
Under our bankruptcy laws, any firm that is in financial distress
will be forced to declare bankruptcy and then be liquidated.
2 points
Question 30
Which of the following statements is CORRECT?
Answer
If a coupon bond is selling at par, its current yield equals its
yield to maturity.
If a coupon bond is selling at a discount, its price will continue
to decline until it reaches its par value at maturity.
If interest rates increase, the price of a 10-year coupon bond
will decline by a greater percentage than the price of a 10-year zero coupon
bond.
If a bond’s yield to maturity exceeds its annual coupon, then the
bond will trade at a premium.
If a coupon bond is selling at a premium, its current yield equals
its yield to maturity.
This quiz consist of 30 multiple choice questions. The first 15
questions cover the material in Chapter 4. The second 15 questions cover the
material in Chapter 5. Be sure you are in the correct Chapter when you take the
quiz.