QUESTION 1:
Which of the following will decrease the present value of the mixed cash flows for years 1 through 5 of $1,000; $4,000; $9,000; $5,000; and $2,000 respectively given a 10% discount rate? (Choose all that apply - this is an all or nothing problem; if you choose an option that is wrong or do not choose an option that is correct, your entire answer will be marked wrong).
Decrease the discount rate by 2%.
Switch cash flows for years 1 and 5 so that year 1 is $2,000 and year 5 is $1,000.
Switch cash flows for years 2 and 4 so that year 2 is $5,000 and year 4 is $4,000.
Switch cash flows for years 2 and 5 so that year 2 is $2,000 and year 5 is $4,000.
Switch cash flows for years 3 and 1 so that year 1 is $9,000 and year 3 is $1,000.
QUESTION 2:
You are taking a loan for 10 years. Which of the following payment options gives you the highest effective annual rate?
A. 9.3% with monthly payments
B. 9.3% with semi-annual payments
C. 9.3% with annual compounding
D. 9.3% with weekly payments
E. 9.3% with continuous compounding
QUESTION 3:
Suppose there is a financial security that promises to give you $2,000 ten years from today. All else constant, for a given nominal interest rate, a change from quarterly compounding to annual compounding will cause the current price of this security to _________________.
A. INCREASE
B. DECREASE
C. REMAIN THE SAME
D. Either increase or decrease depending on the number of years until the money is to be received.
E. NONE OF THE ABOVE
QUESTION 4:
For a given nominal interest rate greater than 0%, if the number of compounding periods per year decreases (for example, from monthly to semiannually), the future value of $1000 to be received exactly 10 years from today will:
A . increase.
B. decrease.
C. remain unchanged.
D. either increase or decrease, depending on the nominal interest rate.
E. None of the answers listed above are correct.
Present value of cash flows occurring early in future is more than cash flows occurring later
Hence, the value will be reduced by those which shifts higher cash flows to later periods
Hence, the answer is
· Switch cash flows for years 2 and 5 so that year 2 is $2,000 and year 5 is $4,000.
2.Effective annual rates increases with the increase in number of compounding periods per annum
Hence, the answer is
E. 9.3% with continuous compounding
3. B. DECREASE
With more compounding, interest will increase and hence, price today will reduce
4. B. DECREASE
Lesser compounding, lesser interest
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