Chapter 5

Question 1

What does the term ‘Time Value of Money’ (TVM) refer to?

Answer 1

The concept that money available today is worth more than the same amount in the future due to its potential earning capacity.

Question 2

True or False: A dollar today is worth more than a dollar in the future.

Answer 2

True

Question 3

What is the formula for Future Value (FV)?

Answer 3

FV = PV * (1 + r)^n

Question 4

Fill in the blank: The rate of return used in TVM calculations is referred to as the __________.

Answer 4

interest rate

Question 5

What does PV stand for in financial calculations?

Answer 5

Present Value

Question 6

If you invest $1,000 at an interest rate of 5% for 3 years, what is the Future Value?

Answer 6

$1,157.63

Question 7

What is the formula to calculate Present Value (PV)?

Answer 7

PV = FV / (1 + r)^n

Question 8

True or False: The longer the time period, the higher the Future Value of an investment.

Answer 8

True

Question 9

What is ‘compounding’ in the context of TVM?

Answer 9

The process of earning interest on both the initial principal and the accumulated interest from previous periods.

Question 10

Define ‘discounting’ in financial terms.

Answer 10

The process of determining the present value of a future amount.

Question 11

What is an annuity?

Answer 11

A series of equal payments made at regular intervals over time.

Question 12

Fill in the blank: An annuity that pays at the end of each period is called a __________ annuity.

Answer 12

ordinary

Question 13

What is the formula for the Present Value of an annuity?

Answer 13

PV = PMT * [(1 - (1 + r)^-n) / r]

Question 14

What do the terms ‘interest rate’ and ‘discount rate’ refer to in TVM?

Answer 14

Interest rate is the rate at which money grows, while the discount rate is the rate used to determine present value.

Question 15

True or False: The effect of compounding increases with time.

Answer 15

True

Question 16

What is the difference between an ordinary annuity and an annuity due?

Answer 16

An ordinary annuity pays at the end of each period, while an annuity due pays at the beginning of each period.

Question 17

What does ‘n’ represent in the TVM formulas?

Answer 17

The number of periods.

Question 18

What is the effective annual rate (EAR)?

Answer 18

The interest rate that is adjusted for compounding over a given period.

Question 19

Fill in the blank: The __________ is the rate that equates the present value of cash inflows with the present value of cash outflows.

Answer 19

internal rate of return

Question 20

What is ‘net present value’ (NPV)?

Answer 20

The difference between the present value of cash inflows and the present value of cash outflows.

Question 21

True or False: A positive NPV indicates that the projected earnings exceed the anticipated costs.

Answer 21

True

Question 22

What is a perpetuity?

Answer 22

A type of annuity that continues indefinitely.

Question 23

What is the formula for the Present Value of a perpetuity?

Answer 23

PV = PMT / r

Question 24

True or False: The time value of money is irrelevant in personal finance.

Answer 24

False

Question 25

What is the impact of inflation on the time value of money?

Answer 25

Inflation decreases the purchasing power of money over time, affecting future cash flows.

Question 26

What does 'real interest rate' account for?

Answer 26

It accounts for the effects of inflation on the nominal interest rate.

Question 27

Fill in the blank: The __________ is the interest rate before adjusting for inflation.

Answer 27

nominal interest rate

Question 28

What is the formula for the real interest rate?

Answer 28

Real interest rate = Nominal interest rate - Inflation rate

Question 29

What is a 'cash flow' in TVM terminology?

Answer 29

Any movement of money into or out of a business or personal account.

Question 30

True or False: Cash inflows and cash outflows are considered in TVM calculations.

Answer 30

True

Question 31

What is the significance of the time value of money in investment decisions?

Answer 31

It helps assess the profitability and viability of investments over time.

Question 32

What is the 'future value of a single sum'?

Answer 32

The value of a single amount of money at a specified date in the future based on a specified interest rate.

Question 33

Fill in the blank: A cash flow that occurs at the end of each period is considered an __________ cash flow.

Answer 33

ordinary

Question 34

What is the primary use of the time value of money concept in finance?

Answer 34

To evaluate investment opportunities and financial decisions.

Question 35

What does the term 'sinking fund' refer to?

Answer 35

A fund established to set aside money over time for a future obligation.

Question 36

True or False: The sinking fund uses the concept of TVM to accumulate funds for future payments.

Answer 36

True

Question 37

What is the formula to calculate the future value of a series of cash flows?

Answer 37

FV = PMT * [((1 + r)^n - 1) / r]

Question 38

What does the term 'risk-adjusted return' mean?

Answer 38

The return on an investment that considers the risk involved in generating that return.

Question 39

Fill in the blank: The __________ is a measure of how much an investment is expected to grow over time.

Answer 39

rate of return

Question 40

What is the purpose of using a financial calculator or software in TVM calculations?

Answer 40

To simplify complex calculations and improve accuracy.

Question 41

True or False: The time value of money only applies to business finance, not personal finance.

Answer 41

False

Question 42

What does the term 'liquidity' refer to in finance?

Answer 42

The ease with which an asset can be converted into cash.

Question 43

What is the relationship between risk and return in finance?

Answer 43

Generally, higher risk is associated with the potential for higher returns.

Question 44

Fill in the blank: The __________ is an important factor to consider when assessing investment opportunities.

Answer 44

time value of money