Question

2) If time has value, why are financial institutions often willing to extend you a 30-year mortgage at a lower annual interest rate than they would charge for a one-year loan?

• a) With a mortgage, the house you purchase acts as collateral for the loan. This reduces the risk associated with the loan and so reduces the compensation the bank requires.

• b) Because time has value, banks charge a lower interest rate on mortgages because they receive repayments for 30 years instead of just one year.

• c) Because time has value and mortgages don't take as long to approve as a one-year loan, the financial institution can charge a lower interest rate.

• d) There is no economic reason for financial institutions to charge a lower interest rate on a 30-year mortgage.

3) Using Core Principle 2, under what circumstances would you expect a job applicant to accept an offer of a low base salary and an opportunity to earn commission over one with a higher base salary and no commission potential?

The applicant would have to expect to earn a  (A) total compensation to accept an offer with a low base salary and commission, as the risk they assume would

be  (B)  when compared to a higher base salary with no commission potential.

(A) a) lower b) higher

(B) a) lower b) higher c) equal

4) If the U.S. Securities and Exchange Commission eliminated its requirement for public companies to disclose information about their finances, what would you expect to happen to the stock prices of these companies?

• a) You should expect the stock prices to fall. Gathering sufficient information upon which to make an informed decision would become much more costly for investors, reducing the demand for the stock at a given price.

• b) You should expect the stock prices to rise. In the absence of official information, investors would perceive these companies to be more risky, increasing the demand for the stock at a given price.

• c) You should expect the stock prices to be unaffected, as information plays no role in financial markets.

• d) You should expect the stock prices to rise. Investors would perceive the stocks in these companies to be less risky, pushing up stock prices.

Answer 1

2: b

Since the banks are now able to receive future cash flows for 30 years instead of just one year they charge a lower interest. Hence option 4 is incorrect since there is an economic reason for the same.

Having the house as collateral will not change the rate of interest charged by banks on account of tenure. Approval process also does not determine the rate charged.

3: a: Higher; b: higher

In a commission based package the same will be accepted only if the total compensation is expected to be higher. There is more risk since commission is unknown.

4: a

Gathering information will be costly and not many would want to do it. This will reduce demand as . well as prices. Option b is wrong since higher risk will reduce the prices/Option c is wrong since prices are based upon information. Option d is incorrect since this will not make the stocks less risky.