Deflation

Which of the following statements is most correct? (Points : 1) If annual compounding is used, the effective annual rate equals the simple rate. If annual compounding is used, the effective annual rate equals the periodic rate. If a loan has a 12 percent simple rate with semiannual compounding, its effective annual rate is equal to 11.66 percent. Both the first and second answers are correct. Both the first and third answers are correct. 2. Why is the present value of an amount to be received (paid) in the future less than the future amount? (Points : 1) Deflation causes investors to lose purchasing power when their dollars are invested for greater than one year. Investors have the opportunity to earn positive rates of return, so any amount invested today should grow to a larger amount in the future.

Investments generally are not as good as those who sell them suggest, so investors usually are not willing to pay full face value for such investments, thus the price is discounted. Because investors are taxed on the income received from investments they never will buy an investment for the amount expected to be received in the future. None of the above is a correct answer. 3. Suppose someone offered you your choice of two equally risky annuities, each paying $5,000 per year for 5 years. One is an annuity due, while the other is a regular (or deferred) annuity. If you are a rational wealth-maximizing investor which annuity would you choose? (Points : 1) The annuity due.

The deferred annuity. Either one, because as the problem is set up, they have the same present value. Without information about the appropriate interest rate, we cannot find the values of the two annuities, hence we cannot tell which is better. The annuity due; however, if the payments on both were doubled to $10,000, the deferred annuity would be preferred. 4. Which of the following statements is correct? (Points : 1) For all positive values of r and n, FVIFr, n > 1.0 and PVIFAr, n > n. You may use the PVIF tables to find the present value of an uneven series of payments. However, the PVIFA tables can never be of use, even if some of the payments constitute n annuity (for example, $100 each year for Years 3, 4, and 5), because the entire series does not constitute an annuity. If a bank uses quarterly compounding for saving accounts, the simple rate will be greater than the effective annual rate. The present value of a future sum decreases as either the simple interest rate or the number of discount periods per year increases. All of the above statements are false. 5. Alice’s investment advisor is trying to convince her to purchase an investment that pays $250 per year.

The investment has no maturity; therefore the $250 payment will continue every year forever. Alice has determined that her required rate of return for such an investment should be 14 percent and that she would hold the investment for 10 years and then sell it. If Alice decides to buy the investment, she would receive the first $250 payment one year from today. How much should Alice be willing to pay for this investment? (Points : 1) $1,304.03, because this is the present value of an ordinary annuity that pays $250 a year for 10 years at 14 percent. $1,486.59, because this is the present value of an annuity due that pays $250 a year for 10 years at 14 percent. $1,785.71, because this is the present value of a $250 perpetuity at 14 percent. There is not enough information to answer this question, because the selling price of the investment in 10 years is not known today. None of the above is correct. 6. A recent advertisement in the financial section of a magazine carried the following claim: “Invest your money with us at 14 percent, compounded annually, and we guarantee to double your money sooner than you imagine.” Ignoring taxes, how long would it take to double your money at a simple rate of 14 percent, compounded annually? (Points : 1)

Approximately 3.5 years Approximately 5 years Exactly 7 years Approximately 10 years Exactly 14 years 7. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly, planning to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky Mountains to become a ski instructor rather than continue in school, so you close out your account. How much money will you receive? (Points : 1) $1,171 $1,126 $1,082 $1,163 $1,008 8. If a 5-year regular annuity has a present value of $1,000, and if the interest rate is 10 percent, what is the amount of each annuity payment? (Points : 1) $240.42 $263.80 $300.20 $315.38 $346.87 9. At an inflation rate of 9 percent, the purchasing power of $1 would be cut in half in 8.04 years. How long to the nearest year would it take the purchasing power of $1 to be cut in half if the inflation rate were only 4%? (Points : 1) 12 years 15 years 18 years 20 years 23 years 10. Assume that you can invest to earn a stated annual rate of return of 12 percent, but where interest is compounded semiannually. If you make 20 consecutive semiannual deposits of $500 each, with the first deposit being made today, what will your balance be at the end of Year 20? (Points : 1) $52,821.19 $57,900.83 $58,988.19 $62,527.47 $64,131.50