Vol. 1 LM1 Practice

Question 1

P2

The nominal risk-free rate is best described as the sum of the real risk-free rate and a premium for:

A. maturity
B. liquidity
C. expected inflation

p. 40

Answer 1

C. expected inflation

Question 2

P3

Which of the following risk premiums is most relevant in explaining the difference in yields between 30-year bonds issued by the US Treasury and 30-year bonds issued by a small private issuer?

A. inflation
B. maturity
C. liquidity

p. 40

Answer 2

C. liquidity

Question 3

P4

The value in six years of $75,000 invested today at a stated annual interest rate of 7% compounded quarterly is closest to:

A. $112,555
B. $113,330
C. $113,733

p. 40

Answer 3

C. $113,733

Question 4

P5

A bank quotes a stated annual interest rate of 4.00%. If that rate is equal to an effective annual rate of 4.08%, then the bank is compounding interest:

A. daily
B. quarterly
C. semiannually

p. 40

Answer 4

A. daily

Question 5

P6

Given a €1,000,000 investment for four years with a stated annual rate of 3% compounded continuously, the difference in its interest earnings compared with the same investment compounded daily is closest to:

A. €1
B. €6
C. €455

p. 41

Answer 5

B. €6
* €1,000,000(1+0.03/365)³⁶⁵⁽⁴⁾-€1,000,000e^0.03(4) = €6

Question 6

P7

A couple plans to set aside $20,000 per year in a conservative portfolio projected to earn 7 percent a year. If they make their first savings contribution one year from now, how much will they have at the end of 20 years?

p. 41

Answer 6

$20,000 [ ((1+ 0.07)²⁰ - 1)/0.07] = $819,909.85

Question 7

P8

Two years from now, a client will receive the first of three annual payments of $20,000 from a small business project. If she can earn 9 percent annually on her investments and plans to retire in six years, how much will the three business project payments be worth at the time of her retirement?

p. 41

Answer 7

$77,894.21

Question 8

P9

A saver deposits the following amounts in an account paying a stated annual rate of 4%, compounded semiannually:
Year 1 ………… $4,000
Year 2 ………… $8,000
Year 3 ………… $7,000
Year 4 ………… $10,000

p. 41

Answer 8

end of year deposits mean no discounting for year 4
* 1.02⁶4,000
* 1.02⁴8,000
* 1.02²7,000
* 1.02⁰10,000 = $30,446.91

Question 9

P10

To cover the first year’s total college tuition payments for his two children, a father will make a $75,000 payment five years from now. How much will he need to invest today to meet his first tuition goal if the investment earns 6 percent annually?

p. 41

Answer 9

$56,044.36

Question 10

P12

A client requires £100,000 one year from now. If the stated annual rate is 2.50% compounded weekly, the deposit needed today is closest to:

A. £97,500
B. £97,532
C. £97,561

p. 41

Answer 10

B. £97,532

Question 11

P13

A client can choose between receiving 10 annual $100,000 retirement payments, starting one year from today, or receiving a lump sum today. Knowing that he can invest at a rate of 5 percent annually, he has decided to take the lump sum. What lump sum today will be equivalent to the future annual payments?

p. 42

Answer 11

$100,000 [1 - (1.05)^-10]/0.05 = $772,173.49

Question 12

P16

An investment pays €300 annually for five years, with the first payment occurring today. The present value (PV) of the investment discounted at a 4% annual rate is closest to:

A. €1,336
B. €1,389
C. €1,625

p. 42

Answer 12

B. €1,389

Question 13

P17

At a 5% interest rate per year compounded annually, the present value (PV) of a 10-year ordinary annuity with annual payments of $2,000 is $15,443.47. The PV of a 10-year annuity due with the same interest rate and payments is closest to:

p. 42

Answer 13

B. $16,216

Question 14

P18

Grandparents are funding a newborn’s future university tuition costs, estimated at $50,000/year for four years, with the first payment due as a lump sum in 18 years. Assuming a 6% effective annual rate, the required deposit today is closest to:

A. $60,699
B. $64,341
C. $68,201

p. 43

Answer 14

First, find the PV of an ordinary annuity in Year 17 that represents the tuition costs
$50,000 [ 1 - (1.06)⁴]/0.06 = $173,255.58
PV₀ = FV / (1.06)¹⁷
$173,255.28 / 1.06¹⁷ = $64,341

Question 15

P20

A perpetual preferred stock makes its first quarterly dividend payment of $2.00 in five quarters. If the required annual rate of return is 6% compounded quarterly, the stock’s present value is closest to:

A. $31
B. $126
C. $133

p. 43

Answer 15

B. 126

Question 16

P21

A sweepstakes winner may select either a perpetuity of £2,000 a month beginning with the first payment in one month or an immediate lump sum payment of £350,000. If the annual discount rate is 6% compounded monthly, the present value of the perpetuity is:

A. less than the lump sum
B. equal to the lump sum
C. greater than the lump sum

p. 43

Answer 16

C. greater than the lump sum