Question

Which of the following is/are correct?
a. An annuity has a greater future value than an annuity due, all else the same.
b. More frequent compounding increases the effective annual rate, all else the same.
c. An asset with an infinite number of future cashflows attached to it cannot have a finite value today.
d. An annuity due is worth more today than an annuity, all else the same.

All else the same, if expected inflation declines, the value of a zero-coupon bond with $1,000 face value should:
a. Decrease
b. Increase
c. Stay the same

5. Suppose you would like to lend $10,000 and you want to pick the loan structure that will earn you the highest total interest possible over the life of the loan. All options you consider have the same annual interest rate. Which one should you pick?
a. A balloon loan with a 10-year term.
b. An amortized loan with a 10-year term and annual payments.
c. An amortized loan with a 10-year term and monthly payments.
d. An amortized loan with a 5-year term and annual payments.
e. An amortized loan with a 5-year term and monthly payments.

Answer 1

1. Options B and D are correct. An annuity due will have more value today as compared to an ordinary annuity it will have one cash flow ahead of it. More frequently compounding does increase the effective annual rate as can be seen in a continuously compounded case.

2. If expected inflation declines, the discount rate declines and hence the bond price increases.

3. Since they have the same interest rates and we want the maximum interest we want to increase the number of years and we don't want to have any intermediate payment as that will reduce our principal which will reduce the interest. Hence option A is correct