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Module 4,5&6 Quizzes and Lesson Checks
Terms in this set (47)
What is the term for the percentage of the principal that a lender charges a borrower for the use of assets?
How is the interest rate expressed?
As a percentage
What is the main purpose of charging interest?
It allows borrowers to pay to use the assets of another entity to accomplish their own goals
What is a component of the required rate of return?
Why would a long-term investment require a higher rate of return?
There is greater risk involved and a higher opportunity cost.
You just inherited $25,000 from a long-lost relative. You decide to put the money in a savings account for the time being. What would be considered an opportunity cost of putting the money in savings?
Buying a brand new car worth $25,000
Five years ago, Ahmed decided he was going to save up to purchase a car with cash. The car he wants is priced at $15,000. He saved $245 a month in an account that gave him enough interest to have $15,000 in five years. Today, he pulled out $15,000 from his account to buy the car, but the price of the car is now $16,562. Which component of the required rate of return did Ahmed forget to consider?
Why is built-in inflation linked to adaptive expectations?
Workers want higher wages to keep their standard of living as prices increase, which pushes the prices even higher
Why does an increased demand for goods and services cause inflation?
An increase in demand often causes an insufficient supply in the market, which causes prices to go up until the demand is once again equal to the supply
What happens to prices in a market in which there is inflation?
What is the compensation for risk given to investors called?
Which type of interest rate is the rate at which invested money grows for a certain period time?
Which component of an interest rate is an indicator of inflation and opportunity cost?
What is the name for the interest rate expressed on an annual basis?
Annual percentage rate
Why is the required rate of return also known as the hurdle rate?
It is the minimum rate that a firm must surpass to accept a project.
What is the inflation rate?
The rate at which the average price level of a basket of goods and services in an economy increases
What does the risk-free rate indicate?
Inflation and opportunity cost
Suppose Sophia is considering a new stock investment for her retirement account. This stock has significant risk, but is quite popular in the market. Inflation for the next few years is expected to be 2-3% per year, and the current U.S. Treasury rates are about 2%. How should she use this information to decide what type of return she can expect from the stock?
Based on the inflation rate, she should expect this stock to provide a return higher than this for the associated risk.
What is the name for a series of equal payments made at the end of consecutive periods over a fixed length of time?
If you invest $10,000 today and then $5,000 each year for the next 5 years into an investment with an interest rate of 4%, you can withdraw $39,248.14 in 5 years. What does $39,248.14 represent?
What is the name for the concept that a dollar today is worth more than a dollar in the future?
Time value of money
You are considering purchasing a house for $250,000. You have two options to finance it. One is a 20-year mortgage with an interest rate of 3.5%, and the other is a 30-year mortgage with an interest rate of 3.5%. Which mortgage option requires you to pay more in total interest?
A 30-year mortgage
Why does the time value of money play an important role in financial decision-making?
Because the benefits of investments received at different times are comparable only when you consider the time value of money
You are calculating the present value of an annuity due of $5,000 a year for 20 years. The discount rate is 3%. What should be the "type" input variable of the PV function?
1 (The type is the cash flow type in the PV function. 1 = BEGIN, or an indication of an annuity due.)
You are calculating the lump sum of money needed now in order to withdraw $10,000 a year over the next 5 years from an account that earns a 3% interest rate. Which Excel function should you use?
Which Excel function should you use when you are finding a present value of uneven cash flows to find the PV in one step?
Twenty years ago, Mateo started an investment account with $2,000. He then invested $100 into the account every month at the end of each month. Today, he has $46,528 in the same account. What is the term for the $100 monthly cash flows?
Lolo invested $30,000 today in an account that gives 3% interest. Starting one year from today, she will be able to pull out little over $3,500 a year. What does the $30,000 represent?
A return is the gain or loss on an investment over some period of time.
Which statement correctly contextualizes what a return is?
What is an expected return?
A hypothesized estimate of future returns under different scenarios based on expectational data
In 1980, the inflation rate was 5% and a particular investment gave a return of 15%. In 2010, the inflation rate was 5% and the same investment gave a return of 12%. In which year did stockholders gain greater purchasing power and why?
1980 because the real rate was higher than in 2010
he word risk is used in many different contexts. How is risk defined in finance?
The possibility that the realized or actual return will differ from the expected return
What makes market risk different from firm-specific risk?
Market risk cannot be diversified away, and firm-specific risk can.
Which statement accurately describes firm-specific risk?
Firm-specific risk is the risk associated with problems that companies may face because of lawsuits, labor problems, or management decisions, among other factors
Which phrase accurately depicts what interest rate risk is?
An example of market risk where the value of a bond is affected by changes in interest rates
Which type of risk can be reduced by adding a variety of different assets into a portfolio?
How is risk separation different from diversification?
Risk separation involves dispersing assets geographically instead of concentrating them in one location.
Which situation is a real-life example of risk transfer?
Buying home insurance—risk is transferred from the policyholder to the insurer
Why would a company or individual want to retain risk?
Both companies and individuals retain risk when they believe that the cost of pursuing an activity is less than the alternative.
Which statement correctly identifies the relationship between systematic risk and different types of firms?
Utility companies have low systematic risk because as the market moves up and down, their level of risk will also move up and down but in a diminished way
How does the amount of time affect the risk associated with different investment vehicles?
Stock investments are more risky over a shorter period of time than over a longer period of time
What tends to happen to the risk of an investment that offers a higher return?
The risk is higher for an investment with a higher return
What makes the expected return subjective and different from other types of returns?
The expected return is based on expectational data and the probability of different scenarios occurring.
A company that produces soap, shampoo, lotion, and other personal care products has recently taken a hit due to a competitor's new product line. The company decides to reduce wages for its labor force to save money while the company focuses on building up its reputation again, but the company's labor force goes on strike to protest the pay cuts. What type of risk does the strike represent?
Which description below correctly identifies one type of price risk?
Operating risk—depends on the effect of the firm's operating decisions on its operating costs
What is the name for the process of "spreading" money over many different assets?
What is default risk?
A firm-specific risk that comes from the probability of a loss resulting from a borrower's failure to repay a contractual obligation
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