1. The Time Value of Money

Question 1

TVM is abbreviation for

Answer 1

Time Value of Money

Question 2

FV is abbreviation for

Answer 2

Future Value

Question 3

PV is abbreviation for

Answer 3

Present Value

Question 4

Discounting is used to calculate

Answer 4

Present Value (PV)

Question 5

Compounding is used to calculate

Answer 5

Future Value (FV)

Question 6

Interest rates can be interpreted as…

Answer 6

Required rate of return; discount rate; opportunity cost of current consumption

Question 7

Explain ‘required rate of return’

Answer 7

The return that investors and savers require to get them to willingly lend their funds

Question 8

Explain ‘discount rate’

Answer 8

If an individual borrows funds at interest rate of 10%, then they should discount payments to be made in the future at that rate to get their equivalent value in current $

Question 9

Explain ‘opportunity cost’

Answer 9

If the market rate of interest on 1-year securities is 5%, earning an additional 5% is the opportunity forgone when current consumption is chosen rather than saving (postponing consumption)

Question 10

Real risk-free rate is…

Answer 10

…a theoretical rate on a single-period loan that has no expectation of inflation

Question 11

Real rate of return is =

Answer 11

real risk-free rate - expected inflation

Question 12

What are T-bills

Answer 12

U.S. Treasury Bills

Question 13

Nominal risk-free rate =

Answer 13

Real risk-free rate + expected inflation rate

Question 14

Securities may have one or more types of risk, and each added risk [increases/decreases] the required rate of return.

Answer 14

increases

Question 15

Default risk is

Answer 15

the risk that a borrower will not make the promised payments in a timely manner

Question 16

Liquidity risk is

Answer 16

the risk of receiving less than fair value for an investment if it must be sold for cash quickly

Question 17

Maturity risk is

Answer 17

the risk that the price of longer-term bonds are more volatile than shorter term bonds. Longer maturity bonds have more maturity risk than shorter-term bonds

Question 18

nominal rate of interest =

Answer 18

nominal risk-free rate + default risk premium + liquidity risk premium + maturity risk premium

Question 19

An interest rate is best interpreted as:
A. a discount rate or a measure of risk
B. a measure of risk or a required rate of return
C. a required rate of return or the opportunity cost of consumption

Answer 19

An interest rate is best interpreted as a required rate of return or the opportunity cost of consumption

Question 20

An interest rate from which the inflation premium has been subtrated is known as:
A. a real interest rate
B. a risk-free interest rate
C. a real risk-free interest rate

Answer 20

An interest rate from which the inflation premium has been subtrated is known as a real interest rate