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Chapter 4
Introduction to Valuation: The Time Value of Money
| Question | Answer |
|---|---|
| The value of an investment after one or more periods of time is called the: | future value. |
| The process of accumulating interest in an investment over time to earn more interest is called: | compounding. |
| Interest on interest refers to the interest earned on: | prior interest payments. |
| Interest earned on both the initial principal and the reinvested interest from prior periods is called: | compound interest. |
| Simple interest is the interest earned on: | the original principal amount invested. |
| The current value of future cash flows discounted at the appropriate discount rate is called the: | present value. |
| The process of finding the present value of some future amount is often called: | discounting |
| The interest rate used to calculate the present value of future cash flows is called the: | discount rate. |
| The valuation calculating the present value of a future cash flow to determine its value today is called __________ valuation. | discounted cash flow |
| Simple interest is based on the concept of receiving interest: | on the initial amount invested only. |
| Over a period of years, an investment in an account which pays 6 percent simple interest will: | increase in value less than an account which pays 6 percent compound interest. |
| A financially wise individual would prefer a loan based on __________ interest and an investment earning __________ interest. | simple; compound |
| Over time, the effects of compound interest increase the future value of a lump sum deposited today by: | an increasing amount each year, given an interest rate that is greater than zero. |
| Which one of the following is the correct formula for the future value of a lump sum invested today? | FV = PV × (1 + r)t |
| Given a rate of return of zero, the future value of a lump sum invested today will always: | remain constant, regardless of the period of time. |
| Over time, the future value of $1,000 invested today at 6 percent, compounded annually, will increase by a(n): | increasing annual amount given the compound interest effect. |
| Sancho deposits $500 in a bank account today which pays 4 percent interest, compounded annually. The amount of interest Sancho earns in year 4 will be: I. equal to the interest earned in year 3. II. greater than the interest earned in year 3. II | II and V only |
| Which one of the following statements is correct concerning the future value of a lump sum deposited into an account which pays compound interest? Assume that the account pays an interest rate that is greater than zero. | The future value will grow by an increasing amount over time because of the compounding effect. |
| Jamie deposits $1,000 into an account paying 6 percent interest, compounded annually. At the same time, Amy deposits $1,000 into an account paying 3 percent interest, compounded annually. Over a 5 year period, | Jamie will earn more than twice the amount of interest that Amy earns. |
| Tom, Dick, and Harry are triplets. They all decide to borrow $1,000 today to go on vacation. They will repay their loans, plus all the accrued interest, in one lump sum exactly 1 year from today. Tom borrows his money at 6 percent simple interest. D | Dick will pay more interest than either Harry or Tom |
| Which one of the following is the correct formula for computing the present value of a lump sum to be received sometime in the future? | PV = FV / (1 + r)t |
| The Monthly Bank pays 3 percent interest, compounded monthly, on their savings accounts. The Daily Bank pays 3 percent interest, compounded daily, on their savings accounts. You want to have $1,000 saved in an account 2 years from today. The am | will be greater if you have your account at The Monthly Bank. |
| All else constant, the present value will __________ as the period of time decreases, given an interest rate greater than zero. | increase |
| The relationship between the present value and the interest rate is best described as: | inverse. |
| The present value of $10,000 to be received in 10 years will __________ if the discount rate is increased. | decrease |
| Given a 6 percent rate of return and a time period of 5 years, the future value will __________ if the present value is increased. | increase |
| The relationship between the present value and the future value is best described as: | direct. |
| Today, you deposit $3,400 in a bank account which pays 4.5 percent simple interest. How much interest will you earn over the next 5 years? | $765.00 |
| You just inherited $10,000. You are investing this money for 2 years at 3.75 percent simple interest. In whole dollars, how much money will you have at the end of the 2 years? | $10,750 |
| The Back Row Co. invested $125,000 at 8 percent compounded annually for 3 years. How much interest on interest did the company earn over this period of time? | $2,464 |
Created by:
martin.2021