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Principles of Finance > Exam 4 > Flashcards

Exam 4 Flashcards

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1
Q

Annuity

A

A level stream of cash flows for a fixed period of time

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2
Q

How many types of Annuities

A

2

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3
Q

Perpetuity

A

a series of equal payments that continues forever

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4
Q

Perpetuity formula

A

perpetuity= cash amount (annuity)/rate

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5
Q

Rate and present value realtionaship

A

inverse

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6
Q

Future value of annuity(fva)

A

value of periodic payments at the end of a specified period

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7
Q

Relationship between the rate of discount and the price of perpetuity

A

inverse and proportional

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8
Q

The relationship between future value of annuity (FVA) and the future value of annuity due

A

FVAD = is FVA times (1+r)

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9
Q

The simplest form of a loan

A

pure discount loan

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10
Q

Identify key variables to figure out which table to use

A

-PVA
-FVA
-periodic rate
-time
-annuity
-pva/annuity (ratio)
-fva/annuity (ratio)

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11
Q

Amortized loan

A

when the lender requires the borrower to repay parts of the loan amount over time

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12
Q

Interest only loan

A

has a repayment plan that calls for the borrower to pay interest each period and to repay the entire principal (the original loan amount) at some point in the future

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13
Q

Pure discount loan

A

(the simiplets form of a loan) and repays a single lump sum at some time in the future

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14
Q

A simple way of amortizing a loan

A

to have the borrower pay the interest each period plus some fixed amount. This approach is common with medium-term business loans.

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15
Q

Truth -in- Lending Law

A

Lenders disclose an APR on all consumer loans, all your loans must show an APR

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16
Q

Principle

A

the amount of money that you borrowed

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17
Q

According to the truth and lending bill you are required to report on APR (truth or false)

A

true

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18
Q

APR

A

annual percentage rate, the interest rate charged per period multiplied by the number of periods per year

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19
Q

EAR

A

effective annaul rate, the interest rate expressed as if it were compounded once per year

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20
Q

How is the effective annual rate (EAR) greater than the APR

A

With Intra-year compounding

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21
Q

Which is more relevant for financial decisions?

A

The EAR is greater than the APR, the EAR is more relevant for financial decisions. Its always the more relevant number.

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22
Q

In multiple cash flow calculations, when is it assumed that cash flows occur?

A

They occur at the end of each period

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23
Q

What is the point of a loan?

A

Point = 1% of a loan

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24
Q

What is a T-bill the same as

A

a pure discount loan

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25
Q

Why are truth and lending laws controversial

A

APR understates the actual interest rates

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26
Q

When is the interest exempt from the federal income tax?

A

municipal bonds

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27
Q

What does the dirty price of a bond represent?

A

The clean price plus accrued interest

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28
Q

What is the difference between a real and a nominal rate of return?

A
  • The real is adjusted for inflation
  • A nominal rate is not adjusted for inflation
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29
Q

What does historical data suggest about the nature of short-term and long-term interest rates?

A

Call provision is an advantage to issuer and disadvantage to investor

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30
Q

What has the lowest cumulative default risk over 20 years?

A

-Triple a, double a, a, and triple b are investment gradings
-When looking at default risk the first three rates have lowest default risk

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31
Q

What does a bond rating say about the risk of fluctuations in a bond’s value resulting from interest rate changes?

A
  • Rated below triple B is a high yield (junk)
    -The price of high rated bond can be very volatile
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32
Q

Is it true that a U.S. Treasury security is risk-free?

A

No because its subject to interest rate risk

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33
Q

With regard to bid and ask prices on a Treasury bond, is it possible for the bid
price to be higher? Why or why not?

A

No, because if it was true the deal would lose money, and the bid price will always be lower

34
Q

The treasury bid and ask quotes are sometimes given in terms of yields, so there would be a bid yield and an ask yield. Which do you think would be larger? Explain.

A

the bid price would be lower on the ask price so the yield for the bid would be higher

35
Q

Are there any circumstances under which an investor might be more concerned about the nominal return on an investment than the real return?

A

It depends on how the future obligations are denominated, if they are denominated in terms of dollars then it’s relevant

36
Q

What is the relationship between the price of a
bond and its YTM?

A

Inverse relationship

37
Q

What is the advantage of a traditional IRA

A

You might be able to qualify for 2 tax deferrals

38
Q

Drawback of traditional IRA

A
  • You have to pay taxes when you take the money
  • When you take the money out you are subject to taxes
39
Q

Par value & face value are the same…?

A

amount you receive on maturity date

40
Q

Par bond

A

the current price is equal to par. Capital gain is 0

41
Q

Discount bond

A

the current price is lower than par leading to a gain

42
Q

Two components of investments

A

future return and initial investment

43
Q

Roth IRA advantage

A
  • when you take the money out it is tax free
  • Roth Ira can make more than traditional because after tax initial investment is higher
44
Q

Drawback of Roth IRA

A

the initial investment is not tax deductible

45
Q

Why would you rather have money now than in the future?

A
  • Inflation
  • Investment opportunities
46
Q

How do we measure the time value of money?

A

interest rate

47
Q

2 types of interests rates

A

compound & simple interest

48
Q

Simple interest

A

is earned only on the principle, the money does not grow that fast because the interest is on the principal only, the is linear growth

49
Q

Compound interest

A

earning interest on interest, interest is converted to and becomes principle, this is exponential growth, the rate stays the same but the interest per period rises gradually

50
Q

Fun Fact about Benjamin Franklin

A
  • He used compound interest
  • to fund student loans
  • in a trust agreement that stated that the money had to be used for student for loans for the first 100 years
51
Q

Future value of a single sum formula

A

FVSS= PV(1+r) ^t

52
Q

What’s the relation between the rate and FVSS

A

Direct

53
Q

What’s the relation between time and FVSS

A

Direct

54
Q

Future value interest factor formula

A

(1+r)^t= FVIF

55
Q

Future Value is the same as?

A

Future Value Interest Factor

56
Q

Periods are represented in what?

A

quarters (4 quarters in a year)

57
Q

EAR formula

A

(1+PR)^t-1=EAR

58
Q

How does inflation affect the rate of interest?

A

Direct relationship

59
Q

How does credit risk affect the interest rate?

A

Direct relationship

60
Q

When you have a tight monetary policy how will it affect the interest?

A

With other things being equal, it will make the rate go up, a term for this is QT(quantitative tightening)

61
Q

Expansionary monetary policy

A

(QE) quantitative expansion, it causes the rate to go down when other things are equal

62
Q

Similarity between chapter 4 &5

A

they both deal with the compound interest

63
Q

What do we mean by the future value of an investment?

A

the number of dollars you’ll have at the end of the specified period

64
Q

What do we mean by compound interest? How does it differs from simple interest

A

Interest on interest, simple interest is interest on principle

65
Q

What are the determinants of interest

A
  • inflation
  • credit risk
  • monetary policy
  • expanision monetary policy
66
Q

Monetary expansion is the same as

A

quantitative expansion (QE)

67
Q

When you raise the interest rate what do you limit

A

monetary spending

68
Q

Present value of a single sum

A

the money you will pay now in exchange for a certain amount to be received in the future

69
Q

The PVSS formula

A

future value of a single sum (fvss)/(1+r)^t

70
Q

Difference between a stock and a bond

A

Bonds are loans from companies (debt) stock is equity/ownernship. The bond pays the interest and stock pays the dividends.
- Bonds have the first claim to the company’s cash flow and assets
- stocks have residual claims, they are paid last.

71
Q

The relationship between PVSS with rate and time

A

inverse

72
Q

The process of discounting a future amount back to the present is the opposite of doing what?

A

Compounding

73
Q

What do we mean by discounted cash flow, or DCF, valuation?

A

calculating the present value of a future cash flow to determine its worth today

74
Q

What is the Rule of 72

A

72/r= number of periods required to double your money

75
Q

In order for a company to refinance what do they have to do?

A

it sells new bonds and pays off old bonds, this happens when rates drop.

76
Q

Yield to maturity (YTM)

A

How investors get compensated

77
Q

When we go into a recession, sooner or later what will happen?

A
  • Interest rates go down.
  • Based on historical evidence. Interest rates that drop are significant drops and continuous.
78
Q

What is the best predictor of mutual funds performance according to morning star?

A

Management operating expense as a percentage of net asset value

79
Q

Why does the treasury have a zero default risk?

A

they can pay off the debt by increasing taxes or creating more money

80
Q

In general, what is the relationship between a stated interest rate and an effective interest rate?

A

The effective interest rate is always higher

81
Q

How do Call provisions make the investment?

A

less desirable because it is possible that they may never have their investment fully mature

Principles of Finance (8 decks)

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