FIN 301 Midterm Study Guide Chapters 3-6 UIC Dr. Özgür Arslan - Ayaydin
FIN 301 Midterm Study Guide Chapters 3-6 UIC Dr. Özgür Arslan - Ayaydin Fin 301
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This 13 page Study Guide was uploaded by David Kavalerchik on Sunday February 28, 2016. The Study Guide belongs to Fin 301 at University of Illinois at Chicago taught by Ozgur Arslan Ayaydin in Spring 2016. Since its upload, it has received 417 views. For similar materials see Intro to Finance in Finance at University of Illinois at Chicago.
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Chapter 3 1. Which of the following will result in a future value of greater than $100? a. PV = $50, r = an annual interest rate of 10%, and n = 8 years. b. PV = $75, r = an annual interest rate of 12%, and n = 3 years. c. PV = $90, r = an annual interest rate of 14%, and n = 1 year. d. All the future values are greater than $100. FV = PV x (1+r)^n Can do on calculator as well. 2. A home improvement firm has quoted a price of $9,800 to fix up John’s backyard. Five years ago John put $7,500 into a home improvement account that has earned an average of 5.25% per year. Does John have enough money in his account to pay for the backyard fixup? a. Yes. John now has exactly $9,800 in his home improvement account. b. No. John has only $9,687 in his home improvement account. c. Yes. John now has $10,519 in his home improvement account. d. There is not enough information to answer this question. FV=PV×(1+r)^n =$7,500×(1.0525)^5 =$9,687 N = 5 I% = 5.25% PV = $7,500 PMT = NA FV = ?? 3. You have purchased a savings bond that will pay $10,000 to your new born child in fifteen years. If the bank discounts this bond at a rate of 3.875% per year, what is today’s price (the present value) for this bond? a. $8,417 b. $8,500 c. $5,654 d. $10,000 PV = FV/(1 + r)^n = $10,000/(1.03875)^15 = $5,654 N = 15 PV = ?? FV = $10,000 I% = 3.875% PMT = NA 4. To determine the present value of a future amount, one should ___ the future cash flows. (pg 61) a. annuitize b. compound c. discount d. multiply 5. Which form of the TVM equation best answers this question: What is the current value of an amount of cash that I will receive at a specific time in the future? Answer is a. 6. The Millville School District had 3,071 students enrolled five years ago. Today the district enrollment is 2,418 students. What has been the annual rate of change of student enrollment in the Millville School District over this time period? a. 5.40% b. 4.25% c. 4.67% d. 4.25% r = (FV/PV)^(1/n) 1 = (2418/3071)^(⅕) 1 = 4.67% N = 5 PV = 3071 FV = 2418 I% = ?? PMT = NA 7. Average U.S. wage in 1990 was $28,960, far higher than the average wages in 1930 of $1,970. What was the average annual increase in wages over this sixtyyear period? a. 3.31% b. 2.45% c. 24.50% d. 4.58% r = (FV/PV)^(1/n) 1 = (28,960/1,970)^(1/60) 1 = 4.58% 8. For much of the twentieth century, new car prices rose at an annual rate of 5.73%. Given a beginning new car price of $600, how long did it take the average new car price to rise to $16,950? Round to the nearest year. a. 40 years b. 60 years c. 70 years d. 100 years FV = PV x (1+r)^n 16950 = 600 x 1.0573^n divide 600 over to the left 28.25 = 1.0573^n log both sides 1.45 = .0242n solve for “n” n = 59.96 years N = ?? PV = $600 FV = $16,950 I% = 5.73 PMT = NA 9. The dividends per share paid by Going Going Gone (GGG) doubled from a starting value of $1.50 in 2000 to a value of $3.00 in 2006 (a sixyear period). What was the approximate average annual rate of growth of GGG’s dividends per share? Use the Rule of 72 to determine your answer. a. GGG’s dividends grew at an annual rate of approximately 12% per year. b. GGG’s dividends grew at an annual rate of approximately 10% per year. c. GGG’s dividends grew at an annual rate of approximately 8% per year. d. GGG’s dividends grew at an annual rate of approximately 6% per year. 72/6 = 12% via the Rule of 72 N = 6 PV = $ 1.5 FV = $3 I% = ?? PMT = NA 10. A manufacturer of LCD television sets has seen sales increase from 125,000 units per year to 500,000 units per year in eight years. What has been the firm’s average annual rate of increase in the number of television sets sold? Use the Rule of 72 to determine your answer. a. The average annual rate of change has been between 10% and 11%. b. The average annual rate of change has been between 18% and 19%. c. The average annual rate of change has been between 15% and 16%. d. There is not enough information to answer this question. N = 4 PV = 125,000 FV = 250,000 I% = ?? PMT = NA Unit sales doubled from 125,000 to 250,000 and doubled again to 500,000 in eight years. Thus, at a doubling rate of every four years, the Rule of 72 suggests an annual rate of 72/4 = 18%. Via the formula, the actual growth rate is 18.92% per year. Chapter 4 1. Your company just sold a product with the following payment plan: $50,000 today, $25,000 next year, and $10,000 the following year. If your firm places the payments into an account earning 10% per year, how much money will be in the account after collecting the last payment? a. $99,000 b. $98,000 c. $88,500 d. $85,000 It says “today” so there IS a T0. Use FV = PV x (1+r)^n “n” for the first payment of $10,000 is 2 because it will be in the account for the next 2 years. “n” for the second payment of $25,000 is 1 because it will sit in there for 1 year. “n” for the last payment of $10,000 is 0 because it doesn’t sit in the account, end of period. 2. Which of the following is not an example of annuity cash flows? a. The university tuition bill you pay every month that is always the same b. The grocery bill that changes every week c. The $3.50 you pay every morning for a bagel and coffee as you run to your first morning class d. All the examples above are annuity cash flows. Annuity is a constant and consistent payment over a time period. Example; I pay rent $500 every month. 3. Which of the following choices will result in a greater future value at age sixtyfive? Choice 1 is to invest $3,000 per year from ages twenty through twentysix (a total of seven investments) into an account and then leave it untouched until you are sixtyfive years old, which is another forty years. Choice 2 is to begin at age twentyseven and make $3,000 deposits into an investment account every year until you are sixtyfive years old (a total of thirtynine investments). Each account earns an average of 10% per year. a. Choice 1 is better than choice 2 because it has a future value of $1,304,146.89, which is greater than the choice 2 future value of $1,204,343.33. b. Choice 2 is better than choice 1 because it has a future value of $1,304,146.89, which is greater than the choice 1 future value of $1,204,343.33. c. Choice 2 is better than choice 1 because it has a future value of $1,288,146.89, which is greater than the choice 1 future value of $1,204,343.33. d. Choice 1 is better than choice 2 because it has a future value of $1,288,146.89, which is greater than the choice 2 future value of $1,204,343.33. For Choice 1: It is an annuity for the first 7 periods, so use the annuity equation. After that use the FV = PV x (1+r)^n because it just sits there for 40 years. The present value is the answer you got from the annuity equation. 4. You have an annuity of equal annual endoftheyear cash flows of $500 that begin two years from today and last for a total of ten cash flows. Using a discount rate of 4%, what are those cash flows worth in today's dollars? ( another example on pg 101) a. $3,899.47 b. $4,055.45 c. $4,380.24 d. $5,000.00 Pay attention to the wording, it says “cash flows in today’s dollars.” Problem gives you the payment, so use the equation for payment. Do not over complicated. 5. A wealthy woman just died and left her pet cats the following estate: $50,000 per year for the next fifteen years, with the first cash flow today. At a discount rate of 3.2%, what is the feline estate worth in today's dollars? a. $588,352.84 b. $607,180.14 c. $750,000.00 d. $774,000.00 PV of an annuity due is just PV of an ordinary annuity x (1+r) It’s asking for the worst in today’s dollars, so present value but it’s also an annuity. MAKE SURE TO SELECT PMT: BEGIN 6. If you borrow $50,000 at an annual interest rate of 12% for six years, what is the annual payment (prior to maturity) on a discount loan? a. $0 b. $6,000.00 c. $8,333.33 d. $12,161.29 Discount loans pay in full at maturity. 7. Amortization tables are useful for each of the following reasons except a. determining the principal balance due if you pay off the loan early. b. determining how much of a total payment is interest and how much is principal for tax purposes. c. determining the regular periodic total payment. d. All the reasons are useful purposes of an amortization table. 8. Marie has a $1,000,000 investment portfolio, and she wishes to spend $87,500 per year as an ordinary annuity. If the investment account earns 6% annually, how long will her portfolio last? a. 11.43 years b. 14.17 years c. 19.86 years d. 23.08 years 9. You currently have $67,000 in an interestearning account. From this account, you wish to make twenty yearend payments of $5,000 each. What annual rate of return must you make on this account to meet your objective? a. 4.16% b. 5.03% c. 6.42% d. 7.32% 10. After winning the lottery, you state that you are indifferent between receiving twenty $500,000 endoftheyear payments (first payment one year from today) and receiving a lump sum payment of $5,734,961 today. What interest rate are you using in your decisionmaking process such that you are indifferent between the two choices? a. 5.00% b. 6.00% c. 7.00% d. 8.00%" N = 20 PV = 5,734,961 FV = NA I% = ?? PMT = 500,000 Chapter 5 1. A company selling a bond is_______ money. a. borrowing b. lending c. taking d. reinvesting 2. Suppose you deposit money in a CD at a bank. Which of the following statements is true? Give all correct answers. a. The bank is borrowing money from you without a promise to repay that money with interest. b. The bank is lending money to you with a promise to repay that money with interest. c. The bank is technically renting money from you with a promise to repay that money with interest. d. The bank is renting money from you, but not borrowing money from you. Explanation: a. When you buy a CD, the bank promises to repay both the principal and interest due. b. When you buy a CD, the bank is not lending money to you but borrowing money from you. d. When you buy a CD, the bank is renting or borrowing money from you and thus it is borrowing. 3. When a lender states or gives interest rates for loan repayments, we assume that they are ___ unless specifically stated otherwise. a. daily rates b. annual percentage rates c. effective annual rates d. APYs 4. Which of the following statements is true? Give all correct answers. a. By decreasing the number of payments per year, you reduce your total cash outflow, but increase your effective borrowing rate. b. By increasing the number of payments per year, you boost your total cash outflow, but increase your effective borrowing rate. c. By increasing the number of payments per year, you reduce your total cash outflow, but increase your effective borrowing rate. d. By increasing the number of payments per year, you reduce your total cash outflow, but decrease your effective borrowing rate. Explanation: All other answers besides c have at least one word that disagrees with the correct words found in c. 5. Monthly interest on a loan is equal to _____. a. the beginning balance times the APR b. the ending balance times the annual percentage rate c. the ending balance times the periodic interest rate d. the beginning balance times the periodic interest rate 6. Suppose you postpone consumption so that by investing at 8% you will have an extra $800 to spend in one year. Suppose inflation is 4% during this time. What is the real increase in your purchasing power? a. $800 b. $600 c. $400 d. $200 Explanation: We can see that an inflation rate of 4% is onehalf of our 8% invest ment rate. Thus, onehalf of the $800, or $400, is the real increase in your purchasing power. 7. The Fisher effect tells us that the true nominal rate actually comprise three components. These three components are ____ a. the nominal rate, the real rate, and inflation b. the real rate, inflation, and the product of the real rate and the nomi nal rate c. the real rate, inflation, and the product of the real rate and inflation d. the real rate and the product of the real rate and inflation 8. The two major components of the interest rate that cause rates to vary across different investment opportunities or loans are . a. the default premium and the bankruptcy premium b. the liquidity premium and the maturity premium c. the default premium and the maturity premium d. the inflation premium and the maturity premium 9. Which of the following statements is false? Give all correct answers. a. A part of the default premium has to do with the frequency of default by the borrower. b. For the home loan, the collateral (the house) is an asset that will increase in value over time (in general) compared with a car loan in which the collateral (the car) decreases in value over time. c. With a car, the potential loss due to default is less than a house because the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan. d. A personal credit card essentially has no collateral, so the potential loss is even higher if the customer defaults on his or her credit card payments. With a house, the potential loss due to default is less than a car be cause the growing value of the asset should be sufficient to cover the outstanding balance (principal) of the loan. 10. Which of the four interest rate components had the greatest average percentage in the period from 1950 to 1999? a. Real rate b. Inflation premium c. Historical interest rates d. Default premium Explanation: From 1950 to 1999, inflation averaged 1.28%, the real rate has aver aged 1.18%, the maturity premium has averaged 0.71% (for twentyyear maturity differences), and the default premium has averaged 0.49% (for equity over government bonds). Chapter 6 1. Five years ago Thompson Tarps, Inc. issued twentyfiveyear 10% annual coupon bonds with a $1,000 face value. Since then, interest rates in general have risen, and the yield to maturity on the Thompson Tarps bonds is now 12%. Given this information, what is the price today for a Thompson Tarps bond? a. $843.14 b. $850.61 c. $1,181.54 d. $1,170.27 N = # of periods I% = Yield to Maturity PV = ? PMT = Face Value x Coupon Rate FV = 1,000 (for this class, unless otherwise specified) On calculator: N = 20 I% = 12 PV = ? -> Alpha → SOLVE to get the answer. PMT = 100 > 1,000 x 10% FV = 1,000 2. Endicott Enterprises, Inc. has issued thirtyyear semiannual coupon bonds with a face value of $1,000. If the annual coupon rate is 14% and the current yield to maturity is 8%, what is the firm’s current price per bond? a. $578.82 b. $579.84 c. $1,675.47 d. $1,678.70 N = # of periods I% = Yield to Maturity PV = ? PMT = Face Value x Coupon Rate FV = 1,000 (for this class, unless otherwise specified) On calculator: N =30 x 2 =  I% = 8% / 2 = [4%] PV = ? -> Alpha → SOLVE to get the answer. PMT = 1,000 x [14%/2] = $70 FV = 1,000 Fill it in for the “period.” 3. Benson Biometrics, Inc. has outstanding $1,000 face value 8% coupon bonds that make semiannual payments and have fourteen years remaining to maturity. If the current price for these bonds is $1,118.74, what is the annualized yield to maturity? a. 6.68% b. 6.67% c. 6.12% d. 6.00% N = # of periods I% = Yield to Maturity PV = PMT = Face Value x Coupon Rate FV = 1,000 (for this class, unless otherwise specified) On calculator: N =14 x 2 =  I% = ? PV = $1,118.76 PMT = 1,000 x [8%/2] = $40 FV = 1,000 4. Delagold Corporation is issuing a zerocoupon bond that will have a maturity of fifty years. The bond’s par value is $1,000, and the current yield on similar bonds is 7.5%. What is the expected price of this bond using the semi annual convention? a. $25.19 b. $250.19 c. $750.00 d. $1,000.00 N = # of periods I% = Yield to Maturity/ # of periods PV = ? PMT = Face Value x Coupon Rate FV = 1,000 (for this class, unless otherwise specified) N = 50 years x 2 = 100 I% = 7.5% / 2 = 3.75% PV = PMT = 0 FV = 1000 5. From 1980 to 2013, the default risk premium differential between Aaarated bonds and Aa rated bonds has averaged between ____. a. 5 and 10 basis points (dont need this) b. 11 and 23 basis points c. 24 and 35 basis points d. 36 and 50 basis points 6. Which of the following bond types may the issuer buy back before maturity? a. Callable bond (dont need this) b. Putable bond c. Convertible bond d. Zerocoupon bond 7. Bonds that pay interest tied to a company’s earnings are ____ bonds. a. income (dont need this) b. exotic c. floatingrate d. variable earnings 8. The U.S. Treasury bill is currently selling at a discount basis of 4.25%. The par value of the bill is $100,000, and it will mature in ninety days. What is the price of this Treasury bill? a. $95,750.00 **** Book has wrong answer.**** b. $98,937.50 c. $98,952.05 d. $99,952.78
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