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.