CHAPTER 5

Question 1

The annual percentage rate indicates the amount of interest including the effect
of compounding.

Answer 1

NO

Question 2

The effective annual rate indicates the amount of interest that will be earned at
the end of one year.

Answer 2

YES

Question 3

Because interest rates may be quoted for different time intervals, it is often
necessary to adjust the interest rate to a time period that matches that of our cash
flows.

Answer 3

YES

Question 4

The annual percentage rate indicates the amount of simple interest earned in one
year.

Answer 4

YES

Question 5

The interest rates that are quoted by banks and other financial institutions are
nominal interest rates.

Answer 5

YES

Question 6

The Federal Reserve determines very short-term interest rates through its
influence on the federal funds rate.

Answer 6

YES

Question 7

Fundamentally, interest rates are determined by the Federal Reserve.

Answer 7

NO

Question 8

The interest rates that banks offer on investments or charge on loans depends on
the horizon of the investment or loan.

Answer 8

YES

Question 9

The yield curve changes over time.

Answer 9

YES

Question 10

We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons.

Answer 10

YES

Question 11

The yield curve tends to be inverted as the economy comes out of a recession.

Answer 11

NO

Question 12

The formulas for computing present values of annuities and perpetuities cannot
be used in situations in which cash flows need to be discounted at different rates.

Answer 12

YES

Question 13

An inverted yield curve is often interpreted as a positive forecast for economic
growth.

Answer 13

NO

Question 14

The rate of growth of your purchasing power is determined by the real interest
rate.

Answer 14

YES

Question 15

An inverted yield curve generally signals an expected decline in future interest
rates.

Answer 15

YES

Question 16

All the formulas for computing present values of annuities and perpetuities are
based upon discounting all of the cash flows at the same rate.

Answer 16

YES

Question 17

When we refer to the “risk-free interest rate,” we mean the rate on U.S.
Treasuries.

Answer 17

YES

Question 18

All borrowers, besides the U.S. Treasury, have some risk of default.

Answer 18

YES

Question 19

Interest rates vary with the investment horizon.

Answer 19

YES

Question 20

When interest on a loan is tax deductible, the effective after-tax interest rate is T ×
(1 - r).

Answer 20

NO

Question 21

Taxes reduce the amount of interest the investor can keep, and we refer to this
reduced amount as the tax effective interest rate.

Answer 21

NO

Question 22

Investors may receive less than the stated interest rate if the borrowing company
has financial difficulties and is unable to fully repay the loan.

Answer 22

YES

Question 23

In general, if the interest rate is r and the tax rate is T, then for each $1 invested
you will earn interest equal to r and owe taxes of T × r on the interest.

Answer 23

YES

Question 24

U.S. Treasury securities are widely regarded to be risk-free because there is
virtually no chance the government will default on these bonds.

Answer 24

YES

Question 25

For a risk-free project, the opportunity cost of capital will typically be greater
than the interest rate of U.S. Treasury securities with a similar term.

Answer 25

NO

Question 26

The investor’s opportunity cost of capital is the best available expected return
offered in the market on an investment of comparable risk and term of the cash
flows being discounted.

Answer 26

YES

Question 27

The opportunity cost of capital is the return the investor forgoes when the
investor takes on a new investment.

Answer 27

YES

Question 28

Interest rates we observe in the market will vary based on quoting conventions,
the term of investment, and risk.

Answer 28

YES