Finance 2000: Vocab Exam 2

All else held constant, the present value of an annuity will decrease if you:

A) increase the annuity's future value.

B) increase the payment amount.

C) increase the time period.

D) decrease the discount rate.

E) decrease the annuity payment.

E) decrease the annuity payment.

Christie is buying a new car today and is paying a $500 cash down payment. She will finance the balance at 6.3 percent interest. Her loan requires 36 equal monthly payments of $450 each with the first payment due 30 days from today. Which one of the following statements is correct concerning this purchase?

A) The present value of the car is equal to $500 + (36 × $450).

B) The $500 is the present value of the purchase.

C) The car loan is an annuity due.

D) To compute the initial loan amount, you must use a monthly interest rate.

E) The future value of the loan is equal to 36 × $450.

D) To compute the initial loan amount, you must use a monthly interest rate.

Which statement is true?

A) All else equal, an ordinary annuity is more valuable than an annuity due.

B) All else equal, a decrease in the number of payments increases the future value of an

annuity due.

C) An annuity with payments at the beginning of each period is called an ordinary

annuity.

D) All else equal, an increase in the discount rate decreases the present value and

increases the future value of an annuity.

E) All else equal, an increase in the number of annuity payments decreases the present

value and increases the future value of an annuity.

D) All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity.

Which one of these is a perpetuity?

A) Trust income of $1,200 a year forever

B) Retirement pay of $2,200 a month for 20 years

C) Lottery winnings of $1,000 a month for life

D) Car payment of $260 a month for 60 months

E) Rental payment of $800 a month for one year

A) Trust income of $1,200 a year forever

Which one of the following can be classified as an annuity but not as a perpetuity?

A) Increasing monthly payments forever

B) Increasing quarterly payments for six years

C) Unequal payments each year for nine years

D) Equal annual payments for life

E) Equal weekly payments forever

D) Equal annual payments for life

Which one of the following statements concerning annuities is correct?

A) The present value of an annuity is equal to the cash flow amount divided by the discount rate.

B) An annuity due has payments that occur at the beginning of each time period.

C) The future value of an annuity decreases as the interest rate increases.

D) If unspecified, you should assume an annuity is an annuity due.

E) An annuity is an unending stream of equal payments occurring at equal intervals of time.

B) An annuity due has payments that occur at the beginning of each time period

Which one of the following qualifies as an annuity payment?

A) Weekly grocery bill

B) Clothing purchases

C) Car repairs

D) Auto loan payment

E) Medical bills

D) Auto loan payment

All else held constant, the future value of an annuity will increase if you:

A) decrease both the interest rate and the time period.

B) increase the time period.

C) decrease the present value.

D) decrease the payment amount.

E) decrease the interest rate.

B) increase the time period.

You are comparing two annuities. Annuity A pays $100 at the end of each month for 10

years. Annuity B pays $100 at the beginning of each month for 10 years. The rate of return

on both annuities is 8 percent. Which one of the following statements is correct given this

information?

9) ______

A) The present value of Annuity A is equal to the present value of Annuity B.

B) Annuity B will pay one more payment than Annuity A will.

C) The future value of Annuity A is greater than the future value of Annuity B.

D) Annuity B has both a higher present value and a higher future value than Annuity A.

E) Annuity A has a higher future value but a lower present value than Annuity B.

D) Annuity B has both a higher present value and a higher future value than Annuity A.

Which one of the following features distinguishes an ordinary annuity from an annuity due?

10) ______

A) Number of equal payments

B) Amount of each payment

C) Frequency of the payments

D) Annuity interest rate

E) Timing of the annuity payments

E) Timing of the annuity payments

Which one of the following is an ordinary annuity, but not a perpetuity?

11) ______

A) $75 paid at the beginning of each monthly period for 50 years

B) $15 paid at the end of each monthly period for an infinite period of time

C) $40 paid quarterly for 5 years, starting today

D) $50 paid every year for ten years, starting today

E) $25 paid weekly for 1 year, starting one week from today

E) $25 paid weekly for 1 year, starting one week from today

A 30-year home mortgage is a classic example of:

12) ______

A) a set of unequal cash flows.

B) an ordinary annuity.

C) a perpetuity.

D) an annuity due.

E) a consol.

B) an ordinary annuity.

You are comparing three investments, all of which pay $100 a month and have an interest

rate of 8 percent. One is ordinary annuity, one is an annuity due, and the third investment is a

perpetuity. Which one of the following statements is correct given these three investment

options?

13) ______

A) To be the perpetuity, the payments must occur on the first day of each monthly

period.

B) The ordinary annuity would be more valuable than the annuity due if both had a life

of 10 years.

C) The present value of the perpetuity must be higher than the present value of either the ordinary annuity or the annuity due.

D) The future value of all three investments must be equal.

E) The present value of all three investments must be equal.

C) The present value of the perpetuity must be higher than the present value of either the ordinary annuity or the annuity due

Which one of the following has the highest effective annual rate?

14) ______

A) 6 percent compounded annually

B) 6 percent compounded semiannually

C) 6 percent compounded quarterly

D) 6 percent compounded daily

E) 6 percent compounded every 2 years

D) 6 percent compounded daily

Assume all else is equal. When comparing savings accounts, you should select the account

that has the:

15) ______

A) lowest annual percentage rate.

B) highest annual percent rate.

C) highest stated rate.

D) lowest effective annual rate.

E) highest effective annual rate.

E) highest effective annual rate.

A credit card has an annual percentage rate of 12.9 percent and charges interest monthly. The effective annual rate on this account:

16) ______

A) will be less than 12.9 percent.

B) can either be less than or equal to 12.9 percent.

C) is 12.9 percent.

D) can either be greater than or equal to 12.9 percent.

E) will be greater than 12.9 percent.

E) will be greater than 12.9 percent.

Which one of the following statements is correct?

17) ______

A) The APR is equal to the EAR for a loan that charges interest monthly.

B) The EAR is always greater than the APR.

C)The APR on a monthly loan is equal to (1+ monthly interest rate)^12-1

D) The APR is the best measure of the actual rate you are paying on a loan.

E) The EAR, rather than the APR, should be used to compare both investment and loan options.

The EAR, rather than the APR, should be used to compare both investment and loan options.

A loan has an APR of 8.5 percent and an EAR of 8.5 percent. Given this, the loan must:

18) ______

A) have a one-year term.

B) have a zero percent interest rate.

C) charge interest annually.

D) must be partially amortized with each loan payment.

E) require the accrued interest be paid in full with each monthly payment.

C) charge interest annually.

Cindy is taking out a loan today. The cash amount that she is receiving is equal to the present value of the lump-sum payment that she will be required to pay two years from today. Which type of loan is this?

19) ______

A) Principal-only

B) Amortized

C) Interest-only

D) Compound

E) Pure discount

E) Pure discount

Travis borrowed $10,000 four years ago at an annual interest rate of 7 percent. The loan term is six years. Since he borrowed the money, Travis has been making annual payments of $700 to the bank. Which type of loan does he have?

20) ______

A) Interest-only

B) Pure discount

C) Compound

D) Amortized

E) Complex

A) Interest-only

Letitia borrowed $6,000 from her bank two years ago. The loan term is four years. Each year, she must repay the bank $1,500 plus the annual interest. Which type of loan does she have?

21) ______

A) Amortized

B) Blended discount

C) Interest-only

D) Pure discount

E) Complex

A) Amortized

Bill just financed a used car through his credit union. His loan requires payments of $275 a month for five years. Assuming that all payments are paid on time, his last payment will pay off the loan in full. What type of loan does Bill have?

22) ______

A) Amortized

B) Complex

C) Pure discount

D) Lump sum

E) Interest-only

A) Amortized

You just borrowed $3,000 from your bank and agreed to repay the interest on an annual basis and the principal at the end of three years. What type of loan did you obtain?

23) ______

A) Interest-only

B) Amortized

C) Perpetual

D) Pure discount

E) Lump sum

A) Interest-only

When a bond's yield to maturity is less than the bond's coupon rate, the bond:

51) ______

A) had to be recently issued.

B) is selling at a premium.

C) has reached its maturity date.

D) is priced at par.

E) is selling at a discount.

B) is selling at a premium.

The yield to maturity on a discount bond is:

52) ______

A) equal to both the coupon rate and the current yield.

B) equal to the current yield but greater than the coupon rate.

C) greater than both the current yield and the coupon rate.

D) less than the current yield but greater than the coupon rate.

E) less than both the current yield and the coupon rate.

C) greater than both the current yield and the coupon rate.

Which one of the following statements is true?

53) ______

A) The current yield on a par value bond will exceed the bond's yield to maturity.

B) The yield to maturity on a premium bond exceeds the bond's coupon rate.

C) The current yield on a premium bond is equal to the bond's coupon rate.

D) A premium bond has a current yield that exceeds the bond's coupon rate.

E) A discount bond has a coupon rate that is less than the bond's yield to maturity.

E) A discount bond has a coupon rate that is less than the bond's yield to maturity.

All else held constant, the present value of a bond increases when the:

54) ______

A) coupon rate decreases.

B) yield to maturity decreases.

C) current yield increases.

D) time to maturity of a premium bond decreases.

E) time to maturity of a zero coupon bond increases.

yield to maturity decreases.

Which one of the following bonds is the most sensitive to changes in market interest rates?

55) ______

A) 5-year, zero coupon

B) 5-year, 5 percent coupon

C) 5-year, 8 percent coupon

D) 10-year, zero coupon

E) 10-year, 5 percent coupon

D) 10-year, zero coupon

An unexpected decrease in market interest rates will cause a:

56) ______

A) coupon bond's current yield to increase.

B) zero coupon bond's price to decrease.

C) fixed-rate bond's coupon rate to decrease.

D) zero coupon bond's current yield to decrease.

E) coupon bond's yield to maturity to decrease.

E) coupon bond's yield to maturity to decrease.

Of these choices, a risk-adverse investor who prefers to minimize interest rate risk is most apt

to invest in:

57) ______

A) 5-year, 7 percent coupon bonds.

B) 20-year, 6 percent coupon bonds.

C) 20-year, zero coupon bonds.

D) 2-year, 7 percent coupon bonds.

E) 3-year, zero coupon bonds.

D) 2-year, 7 percent coupon bonds.

Which one of the following statements concerning sinking funds is correct?

58) ______

A) Bond issuers must fund a sinking fund at the time the bonds are issued.

B) Sinking funds must include at least one "balloon payment."

C) Sinking funds must be funded annually, starting on the issue date.

D) Sinking funds may be used to purchase bonds in the open market.

E) Sinking funds can be used only to call bonds.

D) Sinking funds may be used to purchase bonds in the open market.

A callable bond:

59) ______

A) is generally call protected during the entire term of the bond issue.

B) generally will have a call protection period during the final three years prior to maturity.

C) may be structured to pay bondholders the current value of the bond on the date of call.

D) is prohibited from having a sinking fund also.

E) is frequently called at a price that is less than par value.

C) may be structured to pay bondholders the current value of the bond on the date of call.

A bond has a make-whole call provision. Given this, you know that the:

60) ______

A) bond will always sell at par.

B) call premium must equal the annual coupon payment.

C) call price is directly related to the market rate of interest.

D) call price is inversely related to the market rate of interest.

E) bond must be a zero coupon bond.

D) call price is inversely related to the market rate of interest.

The primary purpose of bond covenants is to:

61) ______

A) meet regulatory requirements.

B) define the bond's repayment terms.

C) protect the bondholders.

D) identify the bond's rating.

E) protect the bond issuer from lawsuits.

C) protect the bondholders.

The primary purpose of protective covenants is to help:

62) ______

A) reduce interest rate risk.

B) the issuer in case of default.

C) protect bondholders from issuer actions.

D) bondholders whose bonds are called.

E) convert bearer bonds into registered form.

C) protect bondholders from issuer actions.

Municipal bonds are:

63) ______

A) generally purchased by tax-exempt investors.

B) risk-free.

C) issued by federal, state, and local governmental bodies.

D) zero coupon bonds.

E) generally callable.

E) generally callable.

Which one of the following individuals is most apt to purchase a municipal bond?

64) ______

A) Minimum-wage employee

B) Retired individual with minimal current income

C) Recent college graduate

D) Tax-exempt organization

E) Highly compensated business owner

E) Highly compensated business owner

Zero coupon bonds:

65) ______

A) are valued using simple interest.

B) are issued only by the U.S. Treasury.

C) create a tax deduction for the issuer only at maturity.

D) are issued at a premium.

E) create annual taxable income to individual bondholders.

E) create annual taxable income to individual bondholders.

A floating-rate bond frequently has a:

66) ______

A) flexible deferred call period.

B) fixed yield to maturity but a flexible coupon payment.

C) government guarantee.

D) fixed-dollar obligation.

E) put provision.

E) put provision.

Which one of the following types of bonds should an investor purchase if he or she is

primarily concerned about ensuring that bond ownership will increase his or her purchasing

power?

67) ______

A) OTC

B) Death

C) CAT

D) PETS

E) TIPS

E) TIPS

Which one of the following types of bonds permits its issuer to forego paying interest

payments if certain natural events cause significant losses?

68) ______

A) PETS

B) PUT

C) CAT

D) PINES

E) LIBOR

C) CAT

Which statement is correct?

69) ______

A) Bond markets have less daily trading volume than equity markets.

B) There are fewer bond issues outstanding than there are equity issues.

C) Municipal bond prices are highly transparent.

D) Bond markets are dealer based.

E) Most bond trades occur on the NYSE.

D) Bond markets are dealer based.

What is the price of a $1,000 face value bond if the quoted price is 102.1?

70) ______

A) $102.10

B) $1,002.10

C) $1,020.01

D) $1,020.10

E) $1,021.00

E) $1,021.00

An upward-sloping term structure of interest rates indicates:

71) ______

A) the real rate of return is lower for short-term bonds than for long-term bonds.

B) there is an indirect relationship between real interest rates and time to maturity.

C) there is an indirect relationship between nominal interest rates and time to maturity.

D) the nominal rate is declining as the real rate rises as the time to maturity increases.

E) the nominal rate is increasing even though the real rate is constant as the time to maturity increases.

E) the nominal rate is increasing even though the real rate is constant as the time to maturity increases.

If inflation is expected to steadily decrease in the future, the term structure of interest rates

will most likely be:

72) ______

A) upward sloping.

B) flat.

C) humped.

D) downward sloping.

E) double-humped.

D) downward sloping.

If intermediate-term, default-free, pure discount bonds have a higher rate of return than either

the comparable shorter-term or longer-term bonds, the term structure of interest rates will be:

73) ______

A) upward sloping.

B) flat.

C) humped.

D) downward sloping.

E) double-humped.

C) humped.

Suppose that a small, rural city in the countryside of North Dakota plans to issue $150,000

worth of 10-year bonds. Which one of the following components of the bond's yield will be

affected by the fact that no active secondary market is expected for these bonds?

74) ______

A) Real rate

B) Liquidity premium

C) Interest rate risk premium

D) Inflation premium

E) Taxability premium

B) Liquidity premium

Which one of the following bonds is most apt to have the smallest liquidity premium?

75) ______

A) Treasury bill

B) Corporate bond issued by a new firm

C) Municipal bond issued by the State of New York

D) Municipal bond issued by a rural city in Alaska

E) Corporate bond issued by General Motors (GM)

A) Treasury bill

What condition must exist if a bond's coupon rate is to equal both the bond's current yield

and its yield to maturity? Assume the market rate of interest for this bond is positive.

76) ______

A) The clean price of the bond must equal the bond's dirty price.

B) The bond must be a zero coupon bond and mature in exactly one year.

C) The market price must exceed the par value by the value of one year's interest.

D) The bond must be priced at par.

E) There is no condition under which this can occur.

D) The bond must be priced at par.

What is the principal amount of a bond that is repaid at the end of the loan term called?

77) ______

A) Coupon

B) Market price

C) Accrued price

D) Dirty price

E) Face value

E) Face value

A bond's annual interest divided by its face value is referred to as the:

78) ______

A) market rate.

B) call rate.

C) coupon rate.

D) current yield.

E) yield to maturity.

C) coupon rate.

On which one of the following dates is the principal amount of a semiannual coupon bond

repaid?

79) ______

A) A portion of the principal is repaid on each coupon date.

B) The entire bond is repaid on the issue date.

C) Half of the principal is repaid evenly over each coupon period with the remainder

paid on the issue date.

D) The entire bond is repaid on the maturity date.

E) Half of the principal is repaid evenly over each coupon period with the remainder

paid on the maturity date.

D) The entire bond is repaid on the maturity date.

A registered form bond is defined as a bond that:

80) ______

A) is a bearer bond.

B) is held in street name.

C) pays coupon payments directly to the owner of record.

D) is listed with the Securities and Exchange Commission (SEC).

E) is unsecured.

C) pays coupon payments directly to the owner of record.

Which one of the following will increase the current value of a stock?

101) ______

A) Decrease in the dividend growth rate

B) Increase in the required return

C) Increase in the market rate of return

D) Decrease in the expected dividend for next year

E) Increase in the capital gains yield

E) Increase in the capital gains yield

Which statement is true?

102) ______

A) From a legal perspective, preferred stock is a form of corporate equity.

B) All classes of stock must have equal voting rights per share.

C) Common shareholders elect the corporate directors while the preferred shareholders

vote on mergers and acquisitions.

D) Preferred dividends provide tax-free income to individual investors.

E) Preferred shareholders prefer noncumulative dividends over cumulative dividends.

A) From a legal perspective, preferred stock is a form of corporate equity.

Which one of the following statements is correct?

103) ______

A) Preferred stock can be callable.

B) Preferred stock generally has a stated liquidation value of $1,000 per share.

C) Dividend payments to preferred shareholders are tax-deductible expenses for the

issuing firm.

D) Preferred dividends are generally variable in amount.

E) Preferred shareholders receive preferential treatment over bondholders in a

liquidation.

A) Preferred stock can be callable.

Companies can list their stock on which one of the following without having to meet

listing requirements or filing financial statements with the SEC?

104) ______

A) Nasdaq Capital Market

B) Over-the-Counter Bulletin Board

C) Pink sheets

D) Nasdaq Global Market

E) NYSE

C) Pink sheets

The net present value:

151) ______

A) decreases as the required rate of return increases.

B) is equal to the initial investment when the internal rate of return is equal to the

required return.

C) method of analysis cannot be applied to mutually exclusive projects.

D) ignores cash flows that are distant in the future.

E) is unaffected by the timing of an investment's cash flows.

A) decreases as the required rate of return increases.

Which one of the following statements is correct?

152) ______

A) The net present value is a measure of profits expressed in today's dollars.

B) The net present value is positive when the required return exceeds the internal rate of return.

C) If the initial cost of a project is increased, the net present value of that project will also increase.

D) If the internal rate of return equals the required return, the net present value will equal zero.

E) Net present value is equal to an investment's cash inflows discounted to today's dollars.

D) If the internal rate of return equals the required return, the net present value will equal zero.

The average accounting return:

153) ______

A) measures profitability rather than cash flow.

B) discounts all values to today's dollars.

C) is expressed as a percentage of an investment's current market value.

D) will equal the required return when the net present value equals zero.

E) is used more often by CFOs than the internal rate of return.

A) measures profitability rather than cash flow.

The internal rate of return is unreliable as an indicator of whether an investment should be accepted given which one of the following?

154) ______

A) One of the time periods within the investment period has a cash flow equal to zero.

B) The initial cash flow is negative.

C) The investment has cash inflows that occur after the required payback period.

D) The investment is mutually exclusive with another investment of a different size.

E) The cash flows are conventional.

D) The investment is mutually exclusive with another investment of a different size.

Which one of the following statements is correct? Assume cash flows are conventional.

155) ______

A) If the IRR exceeds the required return, the profitability index will be less than 1.0.

B) The profitability index will be greater than 1.0 when the net present value is negative.

C) When the internal rate of return is greater than the required return, the net present value is positive.

D) Projects with conventional cash flows have multiple internal rates of return.

E) If two projects are mutually exclusive, you should select the project with the shortest payback period.

C) When the internal rate of return is greater than the required return, the net present value is positive.

Which one of the following is an indicator that an investment is acceptable? Assume cash flows are conventional.

156) ______

A) Modified internal rate of return that is equal to zero

B) Profitability index of zero

C) Internal rate of return that exceeds the required return

D) Payback period that exceeds the required period

E) Negative average accounting return

C) Internal rate of return that exceeds the required return

You are using a net present value profile to compare Projects A and B, which are mutually exclusive. Which one of the following statements correctly applies to the crossover point between these two?

157) ______

A) The internal rate of return for Project A equals that of Project B, but generally does

not equal zero.

B) The internal rate of return of each project is equal to zero.

C) The net present value of each project is equal to zero.

D) The net present value of Project A equals that of Project B, but generally does not equal zero.

E) The net present value of each project is equal to the respective project's initial cost.

D) The net present value of Project A equals that of Project B, but generally does not equal zero.

Which one of the following will occur when the internal rate of return equals the required return?

158) ______

A) The average accounting return will equal 1.0.

B) The profitability index will equal 1.0.

C) The profitability index will equal 0.

D) The net present value will equal the initial cash outflow.

E) The profitability index will equal the average accounting return.

B) The profitability index will equal 1.0.

An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true?

159) ______

A) The internal rate of return exceeds the required rate of return.

B) The investment never pays back.

C) The net present value is equal to zero.

D) The average accounting return is 1.0.

E) The net present value is greater than 1.0.

C) The net present value is equal to zero.

Which one of the following is true if the managers of a firm accept only projects that have a profitability index greater than 1.5?

160) ______

A) The firm should increase in value each time it accepts a new project.

B) The firm is most likely steadily losing value.

C) The price of the firm's stock should remain constant.

D) The net present value of each new project is zero.

E) The internal rate of return on each new project is zero.

A) The firm should increase in value each time it accepts a new project.

If a project with conventional cash flows has a profitability index of 1.0, the project will:

161) ______

A) never pay back.

B) have a negative net present value.

C) have a negative internal rate of return.

D) produce more cash inflows than outflows in today's dollars.

E) have an internal rate of return that equals the required return.

E) have an internal rate of return that equals the required return.

Which one of the following statements is correct?

162) ______

A) The internal rate of return is the most reliable method of analysis for any type of investment decision.

B) The payback method is biased toward short-term projects.

C) The modified internal rate of return is most useful when projects are mutually exclusive.

D) The average accounting return is the most difficult method of analysis to compute.

E) The net present value method is applicable only if a project has conventional cash flows.

B) The payback method is biased toward short-term projects