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1. You hold a winning ticket from your provincial lottery. It entitles the bearer to receive payments of
$50,000 at the end of each of the next 20 years. Given what you know about the time value of money, you
should be able to sell this ticket for no less than $1 million in the open market.
Ans: False
Level: Basic
Type: Concepts
2. You have just won a lottery prize. You can choose to receive $750,000 today or an annual payment of
$50,000 at the end of each of the next 20 years. The interest rate that makes you indifferent between the
two is 2.91%, and at higher rates you should take the lump sum.
Ans: True
Level: Basic
Type: Concepts
Level: Basic
Subject: Annuity
Type: Definitions
Level: Basic
Type: Definitions
Level: Basic
Type: Definitions
6. Annuities where the payments occur at the end of each time period are called ________, whereas
_____________ refer to annuity streams with payments occurring at the beginning of each time period.
A)
ordinary annuities; early annuities
B)
late annuities; straight annuities
C)
straight annuities; late annuities
D)
annuities due; ordinary annuities
E)
ordinary annuities; annuities due
Ans: E
Level: Basic
Type: Definitions
Page 1
7. An annuity stream where the payments occur forever is called a(n) ___________.
A)
annuity due
B)
indemnity
C)
perpetuity
D)
amortized cash flow stream
E)
amortization table
Ans: C
Level: Basic
Subject: Perpetuity
Type: Definitions
8. The interest rate expressed in terms of the interest payment made each period is called the:
A)
Stated interest rate.
B)
Compound interest rate.
C)
Effective annual rate.
D)
Periodic interest rate.
E)
Daily interest rate.
Ans: A
Level: Basic
Type: Definitions
9. The interest rate expressed as if it were compounded once per year is called the:
A)
Stated interest rate.
B)
Compound interest rate.
C)
Effective annual rate.
D)
Periodic interest rate.
E)
Daily interest rate.
Ans: C
Level: Basic
Type: Definitions
10. The interest rate charged per period multiplied by the number of periods per year is called the:
A)
Effective annual rate (EAR).
B)
Annual percentage rate (APR).
C)
Periodic interest rate.
D)
Compound interest rate.
E)
Daily interest rate.
Ans: B
Level: Basic
Type: Definitions
11. A loan where the borrower receives money today and repays a single lump sum at some time in the future
is called a(n) ___________ loan.
A)
amortized
B)
continuous
C)
balloon
D)
pure discount
E)
interest-only
Ans: D
Level: Basic
Type: Definitions
Page 2
12. A loan where the borrower pays interest each period and repays the entire principal of the loan at some
point in the future is called a(n) ___________ loan.
A)
amortized
B)
continuous
C)
balloon
D)
pure discount
E)
interest-only
Ans: E
Level: Basic
Type: Definitions
13. A loan where the borrower pays interest each period, and repays some or all of the principal of the loan
over time is called a(n) __________ loan.
A)
amortized
B)
continuous
C)
balloon
D)
pure discount
E)
interest-only
Ans: A
Level: Basic
Type: Definitions
14. A loan where the borrower pays interest each period, repays part of the principal of the loan over time, and
repays the remainder of the principal at the end of the loan, is called a(n) _____________ loan.
A)
amortized
B)
continuous
C)
balloon
D)
pure discount
E)
interest-only
Ans: C
Level: Basic
Type: Definitions
Level: Basic
Subject: Annuity
Type: Definitions
Level: Basic
Type: Definitions
Page 3
Level: Basic
Type: Definitions
Level: Basic
Subject: Perpetuity
Type: Definitions
Level: Basic
Type: Definitions
Level: Basic
Type: Definitions
21. A pure discount loan is one where the borrower receives money today and repays the loan with:
A)
A single lump sum in the future.
B)
Equal monthly payments called annuity payments.
C)
Partial monthly payments followed by a balloon payment.
D)
Even monthly payments that fully amortize the principal balance.
E)
Monthly interest only payments followed by a balloon payment.
Ans: A
Level: Basic
Type: Definitions
Page 4
22. The process of making regular payments that reduce the principal loan balance is called:
A)
Annuitizing the loan.
B)
Amortizing the loan.
C)
Depleting the loan.
D)
Discounting the loan.
E)
Compounding the loan.
Ans: B
Level: Basic
Type: Definitions
23. The effective annual rate with continuous compounding is expressed as EAR=:
A)
[(1) (APR) (m)] m - 1.
B)
[1 + (Quoted rate) / m]m - 1.
C)
[1- Quoted rate / m]m [r].
D)
eq - 1.
E)
(e) (q) -1.
Ans: D
Level: Basic
Type: Definitions
Level: Basic
Subject: Perpetuity
Type: Definitions
25. You are going to invest $500 at the end of each year for 10 years. Given an interest rate, you can find the
future value of this investment by:
I. Adding the cash flows together and finding the future value of the sum using the appropriate future
value factor.
II. Applying the proper future value factor to each cash flow, then adding up these future values.
III. Finding the present value of each cash flow, adding all of the present values together, then finding
the future value at the end of year 10 of this lump sum.
IV. Finding the present value of the entire payment stream.
A)
II only
B)
III only
C)
II and III only
D)
I, II, and IV only
E)
II, III, and IV only
Ans: C
Level: Basic
Type: Concepts
Page 5
26. Suppose you are evaluating two annuities. They are identical in every way, except that one is an ordinary
annuity and one is an annuity due. Assuming an interest rate of 10%, which of the following is true?
A)
The ordinary annuity must have a higher present value than the annuity due.
B)
The annuity due must have the same present value as the ordinary annuity.
C)
The regular annuity must have a lower future value than the annuity due.
D)
The two annuities will differ in present value by the amount of exactly one of the annuity payments.
E)
The annuity due will be larger than the regular annuity by an amount equal to the present value of the
last annuity payment.
Ans: C
Level: Basic
Subject: Annuities
Type: Concepts
Level: Basic
Subject: Perpetuity
Type: Concepts
28. You are considering two perpetuities which are identical in every way, except that perpetuity A will begin
making annual payments of $P to you two years from today while the first $P payment for perpetuity B will
occur one year from today. It must be true that the present value of perpetuity:
A)
A is greater than that of B by $P.
B)
B is greater than that of A by $P.
C)
B is equal to that of perpetuity A.
D)
A exceeds that of B by the PV of $P for one year.
E)
B exceeds that of A by the PV of $P for one year.
Ans: E
Level: Basic
Type: Concepts
29. In order to compare different investment opportunities (each with the same risk) with interest rates reported
in different manners you should:
A)
Convert each interest rate to an annual nominal rate.
B)
Convert each interest rate to a monthly nominal rate.
C)
Convert each interest rate to an effective annual rate.
D)
Compare them by using the published annual rates.
E)
Convert each interest rate to an APR.
Ans: C
Level: Basic
Type: Concepts
Level: Basic
Type: Concepts
Page 6
31. You have $500 that you would like to invest. You have two choices: Savings account A which earns 8%
compounded annually, or savings account B which earns 7.75% compounded semiannually. Which would
you choose and why?
A)
A because it has a higher effective annual rate.
B)
A because the future value in one year is lower.
C)
B because it has a higher effective annual rate.
D)
B because the future value in one year is lower.
E)
B because it has the higher quoted rate.
Ans: A
Level: Intermediate
Type: Concepts
32. You have $500 that you would like to invest. You have two choices:Savings account A which earns 8%
compounded annually, or savings account B which earns 7.75% compounded monthly. Which would you
choose and why?
A)
A because it has a higher effective annual rate.
B)
A because the future value in one year is lower.
C)
B because it has a higher effective annual rate.
D)
B because the future value in one year is lower.
E)
A because it has the higher quoted rate.
Ans: C
Level: Intermediate
Type: Concepts
33. You are planning to save your Christmas bonuses from work and are comparing savings accounts:Account
A compounds semiannually while account B compounds monthly. If both accounts have the same effective
annual rate of interest and you place only the bonuses in the account, you should choose ___________.
A)
account A because it has a higher APR
B)
account B because it has a higher APR
C)
account B because it is compounded more often
D)
account A because you will pay less in taxes
E)
either since you would be indifferent between the two
Ans: E
Level: Intermediate
Type: Concepts
Level: Basic
Type: Concepts
Page 7
35. Your banker quotes you two different loan payments on a $12,000 car loan, one calling for 36 monthly
payments and the other calling for 24 monthly payments. Both loans have the same APR and EAR. She
then tells you that the shorter loan is a better deal because the total payments you would make over the life
of the loan would be lower. What is she ignoring?
A)
The payment would be lower on the 24 month loan.
B)
The 24 month contract will actually cost you more in total payments, not less.
C)
The interest you could earn by saving the difference between the two loan payments.
D)
The fact that you must make 12 more payments on the longer term loan.
E)
The APR and EAR for the two loans are irrelevant.
Ans: C
Level: Intermediate
Type: Concepts
36. To compare interest rates offered by various financial institutions, you should compare the:
A)
Quoted rates.
B)
Annual percentage rates.
C)
Stated annual rates.
D)
Nominal rates.
E)
Effective annual rates.
Ans: E
Level: Basic
Type: Concepts
37. Which one of the following will increase the present value of an annuity?
A)
Lowering the discount rate
B)
Reducing the cash flow amount
C)
Decreasing the number of payments
D)
Reducing the future value of the cash flow
E)
Lowering the payment amount
Ans: A
Level: Intermediate
Type: Concepts
38. Which one of the following would have the greatest present value?
A)
$1,000 today plus $100 a month for 2 years
B)
$1,000 today plus $200 a month for a year
C)
$1,000 today plus $400 a month for six months
D)
$2,200 today plus $200 a month for six months
E)
$2,200 today plus $100 a month for a year
Ans: D
Level: Intermediate
Type: Concepts
39. Which one of the following will increase the future value of a stream of unequal payments for a ten year
project? The rate of return is positive.
A)
Delaying some cash inflows from years 1 and 2 until year 9
B)
Lowering the discount rate applicable to all ten years
C)
Increasing the initial cash outflow to start the project
D)
Moving more of the cash inflows to the earlier years of the project
E)
Lowering the effective annual rate applicable to the project
Ans: D
Level: Intermediate
Page 8
Type: Concepts
Level: Intermediate
Type: Concepts
Level: Intermediate
Type: Concepts
Level: Intermediate
Subject: Perpetuity
C / (1 + r/12)12.
Type: Concepts
43. Which of the following will increase the effective annual rate?
I. Increasing the frequency of the compounding
II. Decreasing the frequency of the compounding
III. Increasing the stated rate
IV. Decreasing the annual percentage rate
A)
I only
B)
II only
C)
I and III only
D)
I and IV only
E)
II and IV only
Ans: C
Level: Intermediate
Type: Concepts
Page 9
44. Which one of the following is correct concerning the annual percentage rate (APR)?
A)
The APR is greater than the effective annual rate.
B)
The APR formula for rate disclosure is [1 + (r / m)]m - 1.
C)
The APR is the rate which lenders are required to disclose.
D)
The APR is best used to compare offers from various lenders.
E)
The APR considers all the effects of compounding.
Ans: C
Level: Intermediate
Type: Concepts
Level: Intermediate
Type: Concepts
Level: Intermediate
Type: Concepts
47. Tomas wants to save $1,200 a year in a manner that maximizes his savings. To do this, he should:
A)
Deposit $1,200 into his savings account on the last day of each year.
B)
Treat his $100 monthly savings deposits as an annuity due.
C)
Treat his $100 monthly savings deposits as an ordinary annuity.
D)
Deposit $300 into his account at the end of each quarter.
E)
Deposit $600 into his account at the end of every six month period.
Ans: B
Level: Intermediate
Type: Concepts
48. Beatrice has a credit card that applies interest every month to her account balance. In this case, Beatrice is
paying an interest rate that:
A)
Equals the rate stated on her billing statement as the APR.
B)
Is equal to the APR compounded continuously.
C)
Is greater than the APR shown on her billing statement.
D)
Is equal to the annual percentage rate as required by the government.
E)
Will decline automatically as her account balance declines.
Ans: C
Level: Intermediate
Type: Concepts
Page 10
49. If you are borrowing money, which one of the following rates would you prefer?
A)
9% paid annually
B)
9% compounded semi-annually
C)
9% compounded quarterly
D)
9% compounded monthly
E)
9% compounded continuously
Ans: A
Level: Basic
Type: Concepts
50. The effective annual rate on your savings account assumes that:
A)
You withdraw the interest as soon as it is earned.
B)
All interest is withdrawn from the account at the end of each year.
C)
The annual percentage rate varies as the prime rate varies.
D)
All interest is compounded continuously and immediately added to the account balance.
E)
All interest payments are reinvested at the same rate as the original deposit into the account.
Ans: E
Level: Intermediate
Type: Concepts
51. Which one of the following statements concerning an ordinary annuity is true?
A)
An ordinary annuity consists of equal payments that occur at the beginning of each period over a set
period of time.
B)
If two annuities are equal in every way except that one is an ordinary annuity and one is an annuity
due, then the ordinary annuity will have a larger future value than the annuity due.
C)
The future value of an ordinary annuity can be computed by dividing the future value of an annuity
due by (1+r).
D)
If two annuities are equal in every way except that one is an ordinary annuity and one is an annuity
due, then the ordinary annuity will have a larger present value than the annuity due.
E)
Most financial calculators can compute ordinary annuity problems but not annuity due problems.
Ans: C
Level: Intermediate
Type: Concepts
52. Which of the following statements is (are) true concerning a time line?
I. A timeline is a visual drawing depicting cash flows.
II. As you move leftward on a timeline, you move further into the future.
III. Time 0 generally represents today.
IV. A timeline with no future ending point is a perpetuity.
A)
I and II only
B)
I and III only
C)
II and IV only
D)
I, II, and III only
E)
I, III, and IV only
Ans: E
Level: Intermediate
Type: Concepts
53. In the annuity present value formula, the variable "r" must be expressed as a(n):
A)
Annual percentage rate.
B)
Effective annual rate.
C)
Stated annual rate.
D)
Stated rate per period of time t.
E)
Continuously compounded rate.
Ans: D
Level: Intermediate
Type: Concepts
Page 11
54. You are trying to use your financial calculator to solve a present value problem that has unequal cash flows.
You input monies you receive as positive values. Which one of the following statements is true?
A)
Cash outflows should be input as positive values for each year in which they occur.
B)
Any cash flow occurring today should be input as a Year 1 cash flow.
C)
You have annual cash flows starting with Year 1 of $100, $0, $200, and $300. The $300 cash flow
should be input as occurring in year 3.
D)
Because you are solving for the present value, any cash flow that occurs today can be ignored.
E)
A negative present value indicates that this series of cash flows causes you to lose money today
given a certain discount rate.
Ans: E Level: Intermediate
Type: Concepts
55. Which one of the following is correct concerning ordinary annuities and annuities due?
A)
An ordinary annuity will have a larger present value than an annuity due given that the annuities are
otherwise identical.
B)
An annuity due will have a larger future value than an ordinary annuity given that the annuities are
otherwise identical.
C)
An annuity due applies only to equal payments made in annual increments.
D)
The majority of annuities are annuities due.
E)
An ordinary annuity is one where the payment occurs at the beginning of the period.
Ans: B
Level: Intermediate
Type: Concepts
56. What is the total future value six years from now of $50 received in one year, $200 received in two years,
and $800 received in six years if the discount rate is 8%?
A)
$1,050.00
B)
$1,047.93
C)
$1,145.56
D)
$1,237.21
E)
$1,269.15
Ans: C
Level: Intermediate
Type: Problems
57. What is the future value at the end of year 4 of the following set of cash flows? Assume an interest rate of
8%.
Year
1
2
3
4
Cash
$1000
-$1000
$1000
-$1000
Flow
A)
B)
C)
D)
E)
$ 0.00
$ 127.38
$ 173.31
$ 379.41
$3,312.13
Ans: C
Level: Intermediate
Type: Problems
58. What is the future value of the following set of cash flows four years from now? Assume an interest rate of
5.5%.
Year
0
1
2
3
4
Cash
-$800
$100
$300
$500
$700
Flow
Page 12
A)
B)
C)
D)
E)
$555.18
$585.72
$642.12
$687.77
$800.00
Ans: D
Level: Intermediate
Type: Problems
59. You deposit $1,000 in an account today. You will deposit $600 at the end of each month for the next 12
months and $800 each month for the following 12 months. How much interest will you have earned in two
years if the account pays 5.5% compounded monthly?
A)
$795.42
B)
$827.65
C)
$849.42
D)
$962.57
E)
$979.00
Ans: D
Level: Intermediate
Type: Problems
60. When you were born, your dear old Aunt Minnie promised to deposit $1,000 into a savings account bearing
a 5% compounded annual rate on each birthday, beginning with your first. You have just turned 22 and
want the dough. However, it turns out that dear old (forgetful) Aunt Minnie made no deposits on your fifth
and eleventh birthdays. How much is in the account right now?
A)
$31,976
B)
$34,503
C)
$43,888
D)
$47,983
E)
$51,889
Ans: B
Level: Intermediate
Type: Problems
61. What is the total present value of $50 received in one year, $200 received in two years, and $800 received
in six years if the discount rate is 8%?
A)
$482.72
B)
$661.68
C)
$697.25
D)
$721.90
E)
$852.83
Ans: D
Level: Intermediate
Type: Problems
62. Given the following cash flows, what is the present value if the discount rate is 8%?
Year
1
2
3
4
Cash
$200
$350
$800
$1125
Flow
Page 13
A)
B)
C)
D)
E)
$1,115.07
$1,947.23
$2,165.70
$2,358.96
$2,922.62
Ans: B
Level: Intermediate
Type: Problems
63. What is the present value of the following set of cash flows at an 8% discount rate?
Year
1
2
3
4
Cash
$1000
-$1000
$1000
-$1000
Flow
A)
B)
C)
D)
E)
$ 0.00
$ 127.39
$ 173.31
$ 379.41
$3,312.13
Ans: B
Level: Intermediate
Type: Problems
64. Analysts expect Marble Comics to pay shareholders $1.00 per share annually for the next five years. After
that, the dividend will be $1.50 annually forever. Given a discount rate of 10%, what is the value of the
stock today?
A)
$ 6.55
B)
$ 9.87
C)
$12.37
D)
$13.10
E)
$21.88
Ans: D
Level: Intermediate
Type: Problems
65. The monthly mortgage payment on your house is $586.84. It is a 30 year mortgage at a quoted rate of
7.8%. How much did you borrow?
A)
$75,000
B)
$75,500
C)
$80,000
D)
$82,500
E)
$85,000
Ans: D
Level: Intermediate
Type: Problems
Page 14
66. You win the lottery and are given the option of receiving $250,000 now or an annuity of $25,000 at the end
of each year for 30 years. Which of the following is correct? (Ignore taxes)
A)
You cannot choose between the two without first calculating future values.
B)
You will always choose the lump regardless of interest rates.
C)
You will choose the annuity payment if the interest rate is 7%.
D)
You will always choose the annuity.
E)
Comparing the future value of the two alternatives will lead to a different decision than you will
reach from a comparison of the present values.
Ans: C
Level: Intermediate
Type: Problems
67. You are going to withdraw $1,000 at the end of each year for the next three years from an account that pays
interest at a rate of 8% compounded annually. How much must there be in the account today in order for
the account to reduce to a balance of zero after the last withdrawal?
A)
$793.83
B)
$2,577.10
C)
$2,602.29
D)
$2,713.75
E)
$2,775.67
Ans: B
Level: Intermediate
Type: Problems
68. You are going to withdraw $1,000 at the end of each year for the next three years from an account that pays
interest at a rate of 8% compounded annually. The account balance will reduce to zero when the last
withdrawal is made. How much money will be in the account immediately after the second withdrawal is
made?
A)
$925.93
B)
$977.10
C)
$982.29
D)
$1,000.00
E)
$2,000.00
Ans: A
Level: Intermediate
Type: Problems
69. At the end of each year for the next 10 years you will receive cash flows of $50. If the appropriate discount
rate is 5.5%, how much would you pay for the annuity?
A)
$259.82
B)
$299.02
C)
$338.99
D)
$376.88
E)
$379.16
Ans: D
Level: Intermediate
Type: Problems
Page 15
70. Your brother-in-law borrowed $2,000 from you four years ago and then disappeared. Yesterday he returned
and expressed a desire to pay back the loan, including the interest accrued. Assuming that you had agreed
to charge him 10%, and assuming that he wishes to make five equal annual payments beginning in one
year, how much would your brother-in-law have to pay you annually in order to pay off the debt? (Assume
that the loan continues to accrue interest at 10% per year.)
A)
$697.43
B)
$738.63
C)
$751.46
D)
$772.45
E)
$798.24
Ans: D
Level: Intermediate
Type: Problems
71. Mr. Dubofsky just won a "Name That Tune" contest with a grand prize of $250,000. However, the contest
stipulates that the winner will receive $100,000 immediately, and $15,000 at the end of each of the next 10
years. Assuming that he can earn 5% on his money, how much has he actually won?
A)
$92,156.46
B)
$98,225.11
C)
$115,826.02
D)
$215,826.02
E)
$250,000.00
Ans: D
Level: Intermediate
Type: Problems
72. In order to help you through college, your parents just deposited $25,000 into a bank account paying 8%
interest. Starting next year, you plan to withdraw equal amounts from the account at the end of each of the
next four years. What is the MOST you can withdraw annually?
A)
$6,125.43
B)
$6,988.91
C)
$7,133.84
D)
$7,548.02
E)
$8,154.71
Ans: D
Level: Intermediate
Type: Problems
73. You work for a furniture store. You normally sell a living room set for $2,500 and finance the full purchase
price for 30 monthly payments at 24% APR. You are planning to run a zero-interest financing sale during
which you will finance the set over 30 months at 0% interest. How much do you need to charge for the
bedroom set during the sale in order to earn your usual combined return on the sale and the financing?
A)
$2,500
B)
$2,827
C)
$3,349
D)
$3,437
E)
$3,784
Ans: C
Level: Intermediate
Page 16
Type: Problems
74. You work for a furniture store. You normally sell a living room set for $2,500 and finance the full purchase
price for 30 monthly payments at 24% APR. You are planning to run a zero-interest financing sale during
which you will finance the set over 30 months at 0% interest. How much do you need to raise the price of
the bedroom set during the sale in order to earn your usual combined return on the sale and the financing?
A)
$0
B)
$849
C)
$892
D)
$937
E)
$1,284
Ans: B
Level: Intermediate
Type: Problems
75. Four years from now you will receive the first of seven annual $10,000 payments. The current interest rate
is 6%, but by the beginning of year 4, the rate will rise to 8%. What is the present value of this cash flow
stream?
A)
$41,827.25
B)
$42,554.48
C)
$43,713.69
D)
$46,864.48
E)
$55,692.25
Ans: C
Level: Intermediate
Type: Problems
76. You need to borrow $18,000 to buy a truck. The current loan rate is 9.9% compounded monthly and you
want to pay the loan off in equal monthly payments over five years. What is the size of your monthly
payment?
A)
$363.39
B)
$374.04
C)
$381.56
D)
$394.69
E)
$455.66
Ans: C
Level: Basic
Type: Problems
77. You are considering investing $750 in a 10 year annuity. The rate of return you require is 6.5%. What
annual cash flow from the annuity will provide the required return?
A)
$70.77
B)
$102.96
C)
$104.33
D)
$114.31
E)
$129.27
Ans: C
Level: Basic
Type: Problems
Page 17
78. Daryl wishes to save money to provide for his retirement. Beginning one month from now, he will begin
depositing a fixed amount into a retirement savings account that will earn 12% compounded monthly. He
will make 360 such deposits. Then, one year after making his final deposit, he will withdraw $100,000
annually for 25 years. The fund will continue to earn 12% compounded monthly. How much should the
monthly deposits be for his retirement plan?
A)
$189.58
B)
$199.58
C)
$214.21
D)
$234.89
E)
$249.38
Ans: C
Level: Intermediate
Type: Problems
79. What would your payment be on a 10-year, $150,000 loan at 10% interest compounded semiannually
assuming the payments are made annually?
A)
$19,716.67
B)
$20,743.77
C)
$24,411.81
D)
$24,674.60
E)
$25,366.63
Ans: D Level: Challenge
Type: Problems
80. You work for a furniture store. You normally sell a living room set for $2,500 and finance the full purchase
price for 30 monthly payments at 24% APR. You are planning to run a zero-interest financing sale during
which you will finance the set over 30 months at 0% interest. What is the monthly payment on a zerointerest loan that you must charge during the sale in order to earn your usual combined return on the sale
and the financing?
A)
$ 83.33
B)
$ 89.72
C)
$ 95.24
D)
$111.62
E)
$128.43
Ans: D
Level: Challenge
Type: Problems
81. The company you work for will deposit $600 at the end of each month into your retirement fund. Interest
is compounded monthly. You plan to retire 15 years from now and estimate that you will need $2,000 per
month out of the account for the next 20 years. If the account pays 8% compounded monthly, how much
do you need to put into the account in addition to your company deposit in order to meet your objective?
A)
$0.00
B)
$57.59
C)
$90.99
D)
$95.88
E)
$104.49
Ans: C
Level: Challenge
Subject: Annuities
Type: Problems
Page 18
82. You borrowed $1,500 at 6% compounded annually. Your payments are $90 at the end of each year. How
many years will you make payments on the loan?
A)
9 years
B)
10 years
C)
11 years
D)
12 years
E)
forever
Ans: E
Level: Basic
Type: Problems
83. You are going to withdraw $1,000 at the end of each year for the next three years from an account that pays
interest at a rate of 8% compounded annually. The account balance will reduce to zero when the last
withdrawal is made. How much interest will you earn on the account over the three year life?
A)
$0.00
B)
$240.00
C)
$422.90
D)
$576.24
E)
$3,000.00
Ans: C
Level: Intermediate
Type: Problems
84. At the end of each year for the next 10 years you will receive cash flows of $50. The initial investment is
$320. What rate of return are you expecting from this investment?
A)
9.06%
B)
10.27%
C)
12.01%
D)
12.28%
E)
13.21%
Ans: A
Level: Intermediate
Type: Problems
85. You are planning to borrow $2,500. You can repay the loan in 40 monthly payments of $79.06 each or 36
monthly payments of $85.93 each. You decide to take the 40 month loan. During each of the first 36
months you make the loan payment and place the difference between the two payments ($6.87) into a
savings account earning 14.4% APR. Beginning with the 37th payment you will withdraw money from the
savings account to make your payments. How much money will remain in the savings account after your
loan is repaid?
A)
-$5.00
B)
$0.00
C)
$5.25
D)
$19.78
E)
$495.50
Ans: B
Level: Challenge
Type: Problems
Page 19
86. If you deposit $2,500 at the end of each six months into an account which earns 5.5% interest compounded
quarterly, how much will be in the account in five years?
A)
$13,953
B)
$16,931
C)
$26,605
D)
$28,357
E)
$32,188
Ans: D Level: Intermediate
Type: Problems
87. What is the future value in 10 years of $1,000 payments received at the beginning of each year for the next
10 years? Assume an interest rate of 5.625%.
A)
$12,259.63
B)
$12,949.23
C)
$13,679.45
D)
$14,495.48
E)
$14,782.15
Ans: C
Level: Intermediate
Type: Problems
88. What is the present value of $1,000 payments received at the beginning of each year for the next 10 years?
Assume an interest rate of 5.625%.
A)
$7,069.13
B)
$7,093.62
C)
$7,492.64
D)
$7,914.10
E)
$8,165.12
Ans: D
Level: Basic
Type: Problems
89. In order to help you through college, your parents just deposited $25,000 into a bank account paying 8%
interest. Starting tomorrow, you plan to withdraw equal amounts from the account at the beginning of each
of the next four years. What is the MOST you can withdraw annually?
A)
$6,125.43
B)
$6,988.91
C)
$7,133.84
D)
$7,548.02
E)
$8,154.71
Ans: B
Level: Challenge
Type: Problems
90. What is the present value of $1,000 payments received at the beginning of each year for the next 10 years?
Assume an interest rate of 5.49% compounded monthly.
A)
$7,069.13
B)
$7,093.62
C)
$7,492.64
D)
$7,912.50
E)
$7,955.26
Ans: D
Level: Basic
Type: Problems
Page 20
91. You just won the lottery. You and your heirs will receive $25,000 per year forever, beginning one year
from now. What is the present value of your winnings at an 8% discount rate?
A)
$182,500
B)
$200,000
C)
$287,500
D)
$312,500
E)
$337,500
Ans: D
Level: Basic
Type: Problems
92. You own a bond issued by the Canadian Pacific railroad that promises to pay the holder $100 annually
forever. You plan to sell the bond five years from now. If similar investments yield 8% at that time, how
much will the bond be worth?
A)
$918.79
B)
$1,014.28
C)
$1,250.00
D)
$1,489.42
E)
$1,958.20
Ans: C
Level: Basic
Type: Problems
93. Five years from now you will begin to receive cash flows of $75 per year. These cash flows will continue
forever. If the discount rate is 6%, what is the present value of these cash flows?
A)
$799.68
B)
$894.22
C)
$934.07
D)
$990.12
E)
$1,104.67
Ans: D
Level: Basic
Type: Problems
94. Moe purchases a $100, 30-year annuity. Larry purchases a $100 perpetuity. In both cases, payments begin
in one year, and the appropriate interest rate is 10%. What is the present value of Larry's payments that will
occur from year 31 onwards?
A)
$57.31
B)
$58.11
C)
$81.21
D)
More than $100
Ans: A
Level: Challenge
Type: Problems
95. You just won the lottery. You and your heirs will receive $25,000 per year forever, beginning one year
from now. If the present value of the lottery is $416,667, what is the discount rate used to value this
perpetuity?
A)
4.0%
B)
5.0%
C)
6.0%
D)
7.0%
E)
8.0%
Ans: C
Level: Intermediate
Type: Problems
Page 21
96. The preferred stock of Marble Comics currently sells for $31.25 per share. The annual dividend of $2.50 is
fixed. Assuming a constant dividend forever, what is the rate of return on this stock?
A)
4.5%
B)
6.0%
C)
8.0%
D)
9.5%
E)
12.5%
Ans: C
Level: Intermediate
Type: Problems
97. You just won the lottery. You and your heirs will receive $25,000 per year forever, with the first payment
received immediately. What is the present value at an 8% discount rate?
A)
$182,500
B)
$200,000
C)
$287,500
D)
$312,500
E)
$337,500
Ans: E
Level: Basic
Type: Problems
98. Moe purchases a $100 annual perpetuity for which payments begin in one year. Larry purchases a $100
annual perpetuity for which payments begin immediately. If a 10% interest rate is appropriate for both cash
flow streams, which of the following statements is true?
A)
Moe's perpetuity is worth $100 more than Larry's.
B)
Larry's perpetuity is worth $100 more than Moe's.
C)
The perpetuities are of equal value today.
D)
Larry's perpetuity is worth $90.91 more than Moe's.
E)
Moe's perpetuity is worth $90.91 more than Larry's.
Ans: B
Level: Intermediate
Type: Problems
99. Your recently departed rich, eccentric uncle has left for you in his will a large sum of money.
Unfortunately, rather than give you this sum of money immediately, he has instructed the executor of the
will to pay you $10,000 in one year. This payment is to grow by 9% each year and to be made each year
forever. If the appropriate discount rate is 10%, how much have you actually inherited?
A)
$100,000
B)
$1,000,000
C)
$11,111.11
D)
$9,090.90
E)
$10,000,000
Ans: B
Level: Challenge
Type: Problems
Page 22
100. Strapped for cash, your neighbour makes you the following offer. He will pay you back the money he
borrows today over the next 10 years. He will make yearly payments with the first payment being for
$1,000 at the end of this year. The payments will grow by 10% every year thereafter. If the appropriate
discount rate is 12%, how much would you be willing to lend your neighbour today?
A)
$5,650.22
B)
$6,144.57
C)
$8,244.22
D)
$10,000.00
E)
$50,000.00
Ans: C
Level: Challenge
Type: Problems
101. Strapped for cash, your neighbour makes you the following offer. He would like to borrow $10,000 today.
He will repay the $10,000 by making yearly payments with the first payment being for $1,000 at the end of
this year. The payments will grow by 10% every year thereafter. If the appropriate discount rate is 12%,
how long will it take for your neighbour to repay the loan?
A)
12.38 years
B)
10 years
C)
13.28 years
D)
18.32 years
E)
21.38 years
Ans: A
Level: Challenge
Type: Problems
102. Strapped for cash, your neighbour makes you the following offer. He would like to borrow $10,000 today.
He will repay the $10,000 by making 10 yearly payments with the first payment being made at the end of
this year. If the payments are to grow by 10% each year and the appropriate discount rate is 12%, how
much will your neighbour have to pay at the end of the first year?
A)
$108.98
B)
$1,212.97
C)
$1,627.45
D)
$1,769.84
E)
$1,867,94
Ans: A
Level: Challenge
Type: Problems
Level: Basic
Type: Problems
Page 23
Level: Basic
Type: Problems
Level: Basic
Type: Problems
106. You are considering an investment with a quoted return of 10% per year. If interest is compounded daily,
what is the effective return on this investment?
A)
1.11%
B)
10.00%
C)
10.25%
D)
10.47%
E)
10.52%
Ans: E
Level: Basic
Type: Problems
Level: Basic
Type: Problems
108. Vito Corleone will loan you money on a "five-for-six" arrangement; i.e., for every $5 he gives you today,
you give him $6 one week from now. What is the EAR of this loan?
A)
410%
B)
540%
C)
860%
D)
1,040%
E)
13,104%
Ans: E
Level: Basic
Type: Problems
Page 24
109. Fast Eddie's Used Cars will sell you a 1996 Ford Escort for $3,000 with no money down. You agree to
make weekly payments of $40 for two years, beginning one week after you buy the car. What is the EAR
of this loan?
A)
34.43%
B)
36.55%
C)
40.94%
D)
42.34%
E)
53.01%
Ans: C
Level: Basic
Type: Problems
110. You have $10,000 to invest. The First National Bank offers one-year certificates of deposit with a stated
rate of 5.50% compounded quarterly. What rate compounded semiannually would provide you with the
same amount of money at the end of one year?
A)
5.487%
B)
5.500%
C)
5.507%
D)
5.512%
E)
5.538%
Ans: E
Level: Intermediate
Type: Problems
111. You agree to loan your parents $22,000 to buy a new van. They agree to pay you $450 a month for five
years. The ______________________.
A)
interest rate on the loan is 0.75% per month
B)
APR on the loan is 8.17%
C)
EAR on the loan is 8.37%
D)
APR on the loan is 8.68%
E)
EAR on the loan is 8.70%
Ans: E
Level: Basic
Subject: APR/EAR
Type: Problems
112. Fast Eddie's Used Cars will sell you a 1996 Ford Escort for $3,000 with no money down. You agree to
make weekly payments for two years, beginning one week after you buy the car. The stated rate on the
loan is 26%. How much is each payment?
A)
$32.96
B)
$37.06
C)
$38.19
D)
$45.90
E)
$69.65
Ans: B
Level: Intermediate
Type: Problems
113. Vito Corleone will loan you money on a "five-for-six" arrangement; i.e., for every $5 he gives you today,
you give him $6 one week from now. What is the APR of this loan?
A)
410%
B)
540%
C)
860%
D)
1,040%
E)
1,310%
Ans: D
Level: Basic
Type: Problems
Page 25
114. You notice a local consumer finance company is offering 20% APR loans, but compounds interest
continuously. What is the EAR?
A)
12.21%
B)
22.14%
C)
23.61%
D)
24.97%
E)
25.83%
Ans: B
Level: Basic
Type: Problems
115. A given rate is quoted as 12% APR, but has an EAR of 12.55%. What is the rate of compounding during
the year?
A)
Annually
B)
Semiannually
C)
Quarterly
D)
Monthly
E)
Continuously
Ans: C
Level: Intermediate
Type: Problems
116. A given rate is quoted as 8% APR, but has an EAR of 8.33%. What is the rate of compounding during the
year?
A)
Annually
B)
Semiannually
C)
Quarterly
D)
Monthly
E)
Continuously
Ans: E
Level: Intermediate
Type: Problems
117. What continuously compounded rate of return allows you to triple your money in 20 years?
A)
5.49%
B)
5.98%
C)
6.86%
D)
6.92%
E)
8.99%
Ans: A
Level: Intermediate
Type: Problems
118. Your local bank just loaned you $1,500. This amount is net of a 10% discount on the loan proceeds, which
serves as interest on the loan. You are to repay the loan in one year. What is the effective rate at which you
borrowed?
A)
11.00%
B)
11.11%
C)
11.97%
D)
12.58%
E)
12.64%
Ans: B
Level: Intermediate
Type: Problems
Page 26
Level: Basic
Type: Problems
120. How much interest will you pay (in dollars) over the life of the loan? (Assume you make each of the
required 300 payments on time.)
A)
$133,769
B)
$145,583
C)
$170,457
D)
$190,457
E)
$270,457
Ans: A
Level: Basic
Type: Problems
121. Although you will get a 25-year mortgage, you plan to prepay the loan by making an additional payment
each month along with your regular payment. How much extra must you pay each month if you wish to
pay off the loan in 20 years?
A)
$24.56
B)
$54.88
C)
$64.17
D)
$93.28
E)
$106.86
Ans: C
Level: Challenge
Type: Problems
122. Your banker suggests that, rather than obtaining a 25-year mortgage and paying it off early, you should
simply obtain a 15-year loan for the same amount. The rate on this loan is 7.75%. By how much will your
monthly payment be (higher/lower) for the 15-year loan than the regular payment on the 25-year loan?
A)
lower; $111.57
B)
lower; $54.72
C)
higher; $9.26
D)
higher; $155.06
E)
higher; $194.59
Ans: D
Level: Challenge
Type: Problems
Page 27
Level: Basic
Type: Problems
124. Assuming they pay off the loan over the 25 year period as planned, what will the total cost (principal +
interest + down payment) of the house be?
A)
$187,500
B)
$271,996
C)
$354,234
D)
$440,019
E)
$511,390
Ans: D
Level: Basic
Type: Problems
125. What will the outstanding balance of the loan be after 10 years assuming you make the first 120 payments
right on time?
A)
$99,610
B)
$126,308
C)
$136,407
D)
$139,144
E)
$170,509
Ans: B
Level: Intermediate
Type: Problems
126. Suppose Rob wants to pay off the loan in 15 years. How much extra must he pay each month to do so?
A)
$11.25
B)
$201.99
C)
$251.67
D)
$311.95
E)
$314.47
Ans: C
Level: Challenge
Type: Problems
Page 28
Level: Challenge
Type: Problems
128. Given the depreciation schedule above, how much will the car be worth after three years?
A)
$10,000
B)
$12,000
C)
$14,000
D)
$16,000
E)
$20,000
Ans: B
Level: Challenge
Subject: Depreciation
Type: Problems
129. Given the depreciation schedule above, how much will the car be worth after you have made your final
payment?
A)
$4,000
B)
$6,000
C)
$8,000
D)
$10,000
E)
$12,000
Ans: B
Level: Challenge
Subject: Depreciation
Type: Problems
130. Including principal and interest, what is your total cost for this car? (Assume you make all of your
payments on time. )
A)
$20,000
B)
$24,999
C)
$26,750
D)
$27,899
E)
$31,872
Ans: C
Level: Challenge
Type: Problems
131. After which loan payment will you be "right-side up" for the first time? In other words, when does the
market value of the car exceed the outstanding balance of the loan for the first time?
A)
After payment number 1
B)
After payment number 2
C)
After payment number 3
D)
After payment number 4
E)
After payment number 5
Ans: C
Level: Challenge
Type: Problems
Page 29
132. Assume the information as given above, except that you put $2,000 down on the car, so that you only had
to borrow $18,000. Now, after which loan payment will you be "right-side up" for the first time?
A)
After payment number 1
B)
After payment number 2
C)
After payment number 3
D)
After payment number 4
E)
After payment number 5
Ans: A
Level: Challenge
Type: Problems
133. What is the present value of the following set of cash flows if the discount rate is 5.25%?
Year
0
1
Cash Flow
-$1,200
$300
A)
B)
C)
D)
E)
3
$600
$196.87
$205.22
$206.90
$213.64
$223.73
Ans: B
Level: Basic
Type: Problems
134. What is the present value of the following set of cash flows if the discount rate is 11.5%?
Year
0
1
Cash Flow
-$5,000
$900
A)
B)
C)
D)
E)
2
$400
2
$0
3
$3,500
-$50.44
-$16.98
$16.81
$268.37
$425.93
Ans: A
Level: Basic
Type: Problems
135. Sue just signed a contract wherein she will receive the following payments. What is the contract worth to
her today if she can earn 7% on her investments?
Year
0
1
2
Cash Flow
$1,200
$3,500
$2,500
A)
B)
C)
D)
E)
$6,168.67
$6,282.53
$6,295.37
$7,139.87
$8,695.37
Ans: E
Level: Intermediate
Page 30
Type: Problems
136. Jamie is a self-employed consultant. A prospective client has offered her three payment options. Jamie is
currently earning 8.5% on her funds. Which one of the following statements is correct concerning Jamie's
payment options?
Option 1: $10,000 today plus $25,000 at the end of year 2
Option 2: $5,000 today plus $9,000 at the end of year 1 and $22,000 at the end of year 2
Option 3: $36,000 at the end of year 2
A)
At a 2% rate of return Option 3 is the best choice.
B)
At a 6% rate of return Option 1 is the worst choice.
C)
At an 8.5% rate of return Option 2 is the best choice.
D)
At a 0% rate of return all options are equivalent.
E)
At a 6% rate of return, Option 1 is the best choice.
Ans: C
Level: Challenge
Type: Problems
137. What is the future value at the end of year 3 of the following set of cash flows if the interest rate is 8%?
Year
0
1
Cash Flow
-$1,500
$100
A)
B)
C)
D)
E)
2
$100
-$64.93
$366.89
$1,824.64
$2,698.13
$3,714.21
Ans: A
Level: Intermediate
Type: Problems
138. What is the future value at the end of year 3 of the following set of cash flows if the interest rate is 14%?
Year
0
1
2
Cash Flow
$900
$400
-$600
A)
B)
C)
D)
E)
-$649.32
-$268.88
$0
$316.72
$469.23
Ans: E
Level: Intermediate
Type: Problems
139. Poor Dog, Inc. borrowed $135,000 from the bank today. They must repay this money over the next six
years by making monthly payments of $2,215.10. What is the interest rate on the loan?
A)
4.71%
B)
5.65%
C)
6.13%
D)
6.38%
E)
9.63%
Ans: B
Level: Intermediate
Type: Problems
Page 31
3
$
140. A credit card company charges you an interest rate of 1.25% monthly. The annual percentage rate is ____
and the effective annual rate is _______
A)
15.00%; 15.00%
B)
15.00%; 14.55%
C)
14.55%; 15.00%
D)
15.00%; 16.08%
E)
16.08%; 15.00%
Ans: D
Level: Intermediate
Type: Problems
141. A so-called friend has offered to loan you $1,000 for one year. At the end of the year you must pay your
friend $2,000. What is the APR on this loan if interest is compounded daily?
A)
50.00%
B)
69.38%
C)
81.33%
D)
96.30%
E)
100.00%
Ans: B
Level: Intermediate
Type: Problems
142. Freeda Mai has a $65,000 insurance annuity. The company has offered monthly payments for twenty years
as a payout option for this annuity. The insurance company will use a 3% rate of return. How much more
per month would Freda Mai receive if the insurance company would pay her a 5% rate of return on her
annuity?
A)
$13.13
B)
$29.37
C)
$68.48
D)
$71.18
E)
$73.01
Ans: C
Level: Intermediate
Type: Problems
143. Sun Woo wants to purchase an annuity that will pay him $1,000 a month for fifteen years. If he can
negotiate a 4.5% rate of return, how much will he have to pay today in order to purchase this annuity?
A)
$96,489
B)
$123,185
C)
$130,720
D)
$154,327
E)
$185,171
Ans: C
Level: Intermediate
Type: Problems
Page 32
144. Douglass Inc. wants to establish an employee reward program whereby they can pay five employees $1,000
a year each for twenty years. The first payment is to begin one year from today. The company expects to
earn 3.25% on the funds in this program. How much does the company have to deposit today to totally fund
this reward program?
A)
$14,539
B)
$31,333
C)
$42,684
D)
$56,667
E)
$72,697
Ans: E
Level: Intermediate
Type: Problems
145. The Frank Trust would like to gift some money to their local university so that the money gifted will
provide $100,000 to the university each year from now on. The funds are expected to earn an 8% rate of
return. How much money does the Frank Trust have to gift to the university today?
A)
$1,000,000
B)
$1,250,000
C)
$1,500,000
D)
$2,000,000
E)
$2,500,000
Ans: B
Level: Basic
Type: Problems
146. ABC preferred stock pays a $3 annual dividend. The current market rate of return is 8% for this type of
investment. What is one share of ABC preferred stock worth?
A)
$24.00
B)
$30.00
C)
$32.50
D)
$37.50
E)
$38.50
Ans: D
Level: Intermediate
Type: Problems
147. An insurance company is offering monthly payments of $250 for the next twenty years in exchange for a
one-time payment of $40,000 today. What is the rate of return on this offer?
A)
3.63%
B)
4.36%
C)
5.21%
D)
6.39%
E)
7.50%
Ans: B
Level: Intermediate
Type: Problems
Page 33
148. Master Meter is planning on constructing a new $20 million facility. The company plans to pay 20% of the
cost in cash and finance the balance. How much will each monthly loan payment be if they can borrow the
necessary funds for 30 years at 9% compounded monthly?
A)
$128,740
B)
$133,667
C)
$141,982
D)
$148,016
E)
$160,925
Ans: A
Level: Intermediate
Type: Problems
149. Jamie owes $21,750 at a 5% rate of interest. The minimum amount that she must pay monthly is $230.69.
How much faster can she pay off this loan if she makes monthly payments of $300.00?
A)
1.68 years sooner
B)
2.54 years sooner
C)
2.79 years sooner
D)
2.93 years sooner
E)
3.01 years sooner
Ans: D
Level: Challenge
Type: Problems
150. The Friendly Bank wants to earn an effective rate of 9% on its auto loans. If interest is compounded
monthly, what APR must they charge?
A)
8.44%
B)
8.58%
C)
8.65%
D)
9.17%
E)
9.38%
Ans: C
Level: Intermediate
Type: Problems
Level: Intermediate
Type: Problems
152. Jessica will be receiving $3,600 five years from now. Her desire is to get a loan today and then repay it in
one lump sum when she receives her funds. What is the maximum loan Jessica can get today if the bank
changes 8.5% interest?
A)
$2,357.10
B)
$2,394.16
C)
$2,416.36
D)
$2,433.86
E)
$2,501.08
Ans: B
Level: Intermediate
Type: Problems
Page 34
153. There are three factors that affect the present value of an annuity. Explain what these three factors are and
discuss how an increase in each will impact the present value of the annuity.
Ans: The factors are the interest rate, payment amount, and number of payments. An increase in the
payment and number of payments will increase the present value, while an increase in the interest
rate will decrease the present value.
Level: Basic
Type: Essays
154. There are three factors that affect the future value of an annuity. Explain what these three factors are and
discuss how an increase in each will impact the future value of the annuity.
Ans: The factors are the interest rate, payment amount, and number of payments. An increase in any of
these three will increase the future value of the annuity.
Level: Basic
Type: Essays
155. A friend who owns a perpetuity that promises to pay $1,000 at the end of each year, forever, comes to you
and offers to sell you all of the payments to be received after the 25th year for a price of $1,000. At an
interest rate of 10%, should you pay the $1,000 today to receive payment numbers 26 and onwards? What
does this suggest to you about the value of perpetual payments?
Ans: The present value of the perpetuity is $10,000, and the present value of the first 25 payments is
$9,077. 04, thus you should be willing to pay only $922. 96 for payments 26 and onwards. This
suggests that the value of a perpetuity is derived primarily from the payments received early in its
life, and the payments to be received later have little worth today.
Level: Intermediate
Type: Essays
156. You are considering two annuities, both of which make total annuity payments of $10,000 over their life.
Which would be worth more today: annuity A, which pays $1,000 at the end of each year for the next 10
years, or annuity B, which pays $775 at the end of the first year, but the annuity payment grows by $50
each year, reaching $1,225 at the end of year 10? Are there any circumstances in which the two would be
equal? Explain.
Ans: The second annuity weights its payments more toward the back of the period, rather than the front,
making it less valuable unless the discount rate is zero. Some students may get tripped up by the fact
that the two annuities have the same total payments. This would clearly demonstrate a lack of
understanding of the time value of money.
Level: Challenge
Type: Essays
157. Annuity A makes annual payments of $813.73 for each of the next 10 years, while annuity B makes annual
payments of $500 per year forever. At what interest rate would you be indifferent between the two? At
interest rates above/below this break-even rate, which annuity would you choose?
Ans: This requires the students to actually use the present value formulas, setting the present value annuity
equal to the present value of a perpetuity and solving for the interest rate that makes the two
equivalent. The first step is recognizing that the indifference point occurs when the two present
values are equal. The break-even rate is 10%:below that rate, the perpetuity is better, while above
that rate, the 10-year annuity is preferred.
Level: Challenge
Type: Essays
Page 35
158. Using the example of a savings account, explain the difference between the EAR and the APR.
Ans: The EAR is what you actually earn, the APR is a quoted rate. If interest is compounded during the
year, the ending balance of a savings account cannot be calculated directly using the APR. Also, in
the case of the savings account, the EAR will always be higher than the APR as long as the account
is compounded more than once a year and the interest rate is greater than zero.
Level: Basic
Type: Essays
159. If you ran a bank, which rate would you rather advertise on monthly-compounded loans, the EAR or the
APR? Which rate would you rather advertise on quarterly-compounded savings accounts, the EAR or the
APR? Explain. As a consumer, which would you prefer to see and why?
Ans: A bank would rather advertise the APR on loans since this rate appears to be lower and the EAR on
savings accounts since this appears to be higher. As a consumer, the EAR is the more important rate
since it represents the rate actually paid or earned.
Level: Basic
Type: Essays
160. Should lending laws be changed to require lenders to report the EAR rather than the APR? Explain.
Ans: It would be more meaningful for consumers to know the EAR rather than the APR. The EAR is
slightly more difficult to calculate and also more difficult to explain, and may add confusion to the
loan process. However, regardless of the costs, it would appear that consumers would benefit from
learning what the EAR is as opposed to the APR.
Level: Basic
Type: Essays
161. Explain both the mathematical difference between APR and EAR for a monthly stream of cash flows and
also how time affects this difference.
Ans: The annual percentage rate is equal to the monthly rate multiplied by 12. The effective annual rate is
a compounding of the monthly rate to the 12th power. The difference between a straight
multiplication and the compounding effects of raising a number to a power magnifies as time
increases.
Level: Intermediate
Type: Essays
162. Explain how increasing the amount of each monthly payment affects an amortized loan.
Ans: An amortized loan is a loan where the monthly payment includes both interest and principal. The
interest is calculated based on the remaining principal balance. When the monthly loan payment is
increased, the additional amount reduces the principal balance. This in turn reduces the amount of
interest due for each remaining payment over the life of the loan. Thus, the extra principal payment
saves future interest expenditures.
Level: Intermediate
Type: Essays
Page 36