CHAPTER 5 Flashcards
The annual percentage rate indicates the amount of interest including the effect
of compounding.
NO
The effective annual rate indicates the amount of interest that will be earned at
the end of one year.
YES
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.
YES
The annual percentage rate indicates the amount of simple interest earned in one
year.
YES
The interest rates that are quoted by banks and other financial institutions are
nominal interest rates.
YES
The Federal Reserve determines very short-term interest rates through its
influence on the federal funds rate.
YES
Fundamentally, interest rates are determined by the Federal Reserve.
NO
The interest rates that banks offer on investments or charge on loans depends on
the horizon of the investment or loan.
YES
The yield curve changes over time.
YES
We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons.
YES
The yield curve tends to be inverted as the economy comes out of a recession.
NO
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.
YES
An inverted yield curve is often interpreted as a positive forecast for economic
growth.
NO
The rate of growth of your purchasing power is determined by the real interest
rate.
YES
An inverted yield curve generally signals an expected decline in future interest
rates.
YES
All the formulas for computing present values of annuities and perpetuities are
based upon discounting all of the cash flows at the same rate.
YES
When we refer to the “risk-free interest rate,” we mean the rate on U.S.
Treasuries.
YES
All borrowers, besides the U.S. Treasury, have some risk of default.
YES
Interest rates vary with the investment horizon.
YES
When interest on a loan is tax deductible, the effective after-tax interest rate is T ×
(1 - r).
NO
Taxes reduce the amount of interest the investor can keep, and we refer to this
reduced amount as the tax effective interest rate.
NO
Investors may receive less than the stated interest rate if the borrowing company
has financial difficulties and is unable to fully repay the loan.
YES
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.
YES
U.S. Treasury securities are widely regarded to be risk-free because there is
virtually no chance the government will default on these bonds.
YES
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.
NO
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.
YES
The opportunity cost of capital is the return the investor forgoes when the
investor takes on a new investment.
YES
Interest rates we observe in the market will vary based on quoting conventions,
the term of investment, and risk.
YES
