Question

1. Calculate the effective annual rate associated with a 7 percent stated rate that is compounded semi-annually.

a. 16.5%

b. 10%

c. 7.12%

d. 9.31%

.

2. A contract specifies that you will receive $1000 in one year, $1040 in two years, and annual payments that continue to grow at a 4% rate forever. If the appropriate discount rate is 7.5%, what is the value of this contract?

a. $28571.4

b. $28333.33

c. $22222.22

d. $25111.11

Answer 1

1)compounded semi annual n=2

perodic rate=apr/no of periods

=7/2

=3.5%

EIR= (1+periodic rate)^m - 1

=(1+3.5%)² - 1

=1.0712-1

=0.0712

=7.12%

OPTION C IS CORRECT

2)VALUE OF CONTRACT= present value of first and second year payment+pv of terminal value on second year end

terminal value on second year end= cash flow in year 2(1+grothrate)/(discounth rate-growth rate)

=1040(1+4%)/(7.5%-4%)

=1081.6/0.035

=30902.9

CONTRACT VALUE = 28571.4

option A IS CORRECT

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