Finance 302 - Exam 2 - Study Guide Answers - Chris Whaley - University of Alabama

T or F: time value of money rewards those who are willing to wait

true

sometimes payments are made in unequal amounts, so you have to treat each one as its own sum

multiple mixed cash flows

An auto dealer gives you the option to pay for your car in one installment of $8,000 and two additional installments of $4,000. You could describe this as ____________ __________ __________ ____________

multiple mixed cash flows

a level stream of cash flows at regular intervals with a finite maturity

annuities

annuities that are paid at the beginning of each period

annuity due

annuities that are paid at the end of each period

ordinary annuity

rent and insurance are examples of annuities that are paid at the beginning of each period. is this an annuity due or an ordinary annuity?

annuity due

mortgage and loan payments are examples of annuities that are paid at the end of each period. is this an annuity due or an ordinary annuity?

ordinary annuity

What is the formula for future value annuity due?

FV (annuity due) = FV (ordinary annuity) x (1 + r)

What is the formula for present value annuity due?

PV (annuity due) = PV (ordinary annuity) x (1 + r)

an annuity that has no definite end, continues forever

perpetuity

What is the formula for a perpetuity?

PV = C / r

repaying a loan or debt via an annuity cash flow

amortization

Which of the following statements is true about amortization?

a. a constant periodic payment pays off the interest and part of the principal balance each period

b. last payment covers what is left over from interest and principal amount

c. the amount gets smaller and smaller after each payment is made

d. a level stream of cash flows at regular intervals with a finite maturity

a. a constant periodic payment pays off the interest and part of the principal balance each period

b. last payment covers what is left over from interest and principal amount

c. the amount gets smaller and smaller after each payment is made

auto loans with monthly payments, student loans, credit cards, etc. are examples of ________________________________

amortization

amortization involves _________________ payments that reduce the _____________________ and ______________ until it's all gone

fixed, principal, interest

annual interest if interest was charged once per year

annual percentage rate

T or F: most common rate quoted by financial institutions is effective annual rate

false, APR

What is the formula for APR?

APR = r x M

r = rate

M = # of times interest is charged

the true rate of return to the lender and true cost to borrower

effective annual rate

EAR takes into account _______________ payments

non-annual

the more compounding periods, the ___________ the interest rate

higher

Having more compounding periods is better for ____________ and worse for ________________

lenders, borrowers

a security that obligates the issuer to make specified payments to the bondholder

bond

payment at maturity of bond

par value (face value)

annual interest rate paid as a % of par value

coupon rate

regular interest payment received by holder

coupon

expiration date of bond when par value is paid back

maturity date

expected rate of return based on price of bond

yield to maturity

the process of determining fair value of a bond interest

bond pricing

As the YTM goes down, the bond prices go ______

up

most companies and government bonds pay coupons on a _______________ basis

semi-annual

T or F: Some companies issue zero-coupon bonds by selling them at a deep discount

true

T or F: for computing the price of these bonds, the values of the inputs have to be adjusted according to frequency of yield to maturity

false, coupons

expected rate of return on the bond if held to maturity

yield to maturity

T or F: Yield to maturity changes in economic conditions and risk factors which also changes bond prices

true

the periodical payments in the form of a percentage that the issuer is offering

coupon rate

T or F, the coupon rate is the face value you will receive if bond is kept to maturity

false, yield to maturity

T or F: the longer bonds are kept, the more sensitive they are to rate changes

true

the lower the YTM, the ____________ the bond price

higher

bonds that can be redeemed or "paid" back by issuer before maturity rate

callable bonds

for callable bonds, issuer pays the call price for the bond which is usually the ___________ value plus _____________ accrued thus far

par, coupon

an additional amount of money paid by the bond issuer to the bondholder if the bond is called before maturity

call premium

specific time during which a bond can be called

call window

period in which bond cannot be called

call protection

T or F: US federal bonds are considered some of the riskiest bonds you can go after

false

involves the bond issuer not paying on its bond obligations (either coupon or face value)

default (credit) risk

the diff between the return on federal bonds (safe) and corporate bonds (risky) is that

default premium

organizations that provide insight into a bond's risk with their rating scale

credit rating agencies

common ratings from two major credit rating firms

bond ratings

a ranking of debt priority to be serviced

seniority

T or F, seniority states that a senior claim is paid first before any subordinate (junior claims)

true

debt that is backed by collateral that can be claimed by the firm if borrower defaults on the loan (can't pay back)

secured debt

restrictions imposed by the bondholders on the use of borrowed funds

protective convenants