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Personal Finance: An Integrated Planning Approach, 8e (Frasca) Chapter 2

1

The Time Value of Money: All Dollars Are Not Created Equal

1)

2

Compounding refers to the A)

3

mistake of confusing present values with future values. B)

4

process of accumulating value over time. C)

5

task of finding a present value. D)

6

projection of future payments. Answer :

7

B Diff: 1 Topic :

8

Interest compounding

2)

9

Assuming positive interest rates, a present value of $1,000 A)

10

is always more desirable to a future value of $1,000. B)

11

is always less desirable than a future value of $1,000. C)

12

is no more or no less desirable than a future value of $1,000. D)

13

You can't answer without more information. Answer :

14

A Diff: 1 Topic :

15


3)

16

Given recent market experience a dollar today is worth A)

17

more than a dollar five years from now. B)

18

less than a dollar five years from now. C)

19

about the same as a dollar five years from now. D)

20

more or less than a dollar five years from now. Answer :

21

A Diff: 1 Topic :

22

Economic trends

4)

23

You have just put $1,000 in an investment that offers a 12% annual yield, using a simple interest calculation. At the end of two years your interest earned will be

A)

24

$120.00. B)

25

$144.00. C)

26

$240.00. D)

27

$254.40. Answer :

28

C Diff: 1 Topic :

29


5)

30

You have just put $500 in an investment that offers an 8% annual yield, with interest compounded annually. Your total interest earned after two years will be

A)

31

$83.20. B)

32

$80.00. C)

33

$44.60. D)

34

$40.00. Answer :

35

A Diff: 2 Topic :

36


37

6)

38

At 12% interest (compounded annually), $20,000 invested today will grow to $________ in three years.

A)

39

27,200 B)

40

28,099 C)

41

31,471 D)

42

40,000 Answer :

43

B Diff: 1 Topic :

44

Future value

7)

45

You have just put $5,000 into an investment that offers a 10% annual yield, using a simple interest calculation. At the end of two years your interest earned will be

A)

46

$500. B)

47

$550. C)

48

$1,000. D)

49

$1,100. Answer :

50

C Diff: 2 Topic :

51


8)

52

You have just put $5,000 into an investment that offers a 10% annual yield, with interest compounded annually. Your total interest earned after two years will be

A)

53

$550. B)

54

$1,000. C)

55

$1,050. D)

56

$1,100. Answer :

57

C Diff: 2 Topic :

58


9)

59

The text discusses the topic of compounding over a large number of compounding periods. To illustrate, it shows that $1,000 invested at 8% for 40 years (annual compounding) grows to $21,724. But if you could earn 10% instead of 8%, you would earn ________ more at the end of 40 years.

A)

60

$4,431 B)

61

25 percent C)

62

$23,535 D)

63

$1,250 Answer :

64

C Diff: 3 Topic :

65


10)

66

The future value of $12,000 invested today at 6% interest compounded annually for 4 years is

A)

67

$23,259. B)

68

$15,150. C)

69

$12,190. D)

70

$9,505. Answer :

71

B Diff: 1 Topic :

72

Future value

73

11)

74

The future value of $5,000 invested today at 3% interest compounded annually for 5 years is

A)

75

$5,255. B)

76

$5,520. C)

77

$5,628. D)

78

$5,796. Answer :

79

D Diff: 3 Topic :

80

Future value

12)

81

You expect a 3% rate of inflation to continue indefinitely into the future. A $10,000 vacation today will cost $________ twenty years from now. (Table or calculator required.)

A)

82

10,300 B)

83

14,988 C)

84

18,061 D)

85

42,944 Answer :

86

C Diff: 3 Topic :

87

Future value

13)

88

You are deciding whether to start a 40-year retirement investing plan now, or ten years from now. You think rates of return will be about the same in the future as they are now. Discussion in the text of this decision shows

A)

89

very little difference in the future value of an investment made now versus one made 10 years from now.

B)

90

an investment made now will accumulate about 20% more (at a 10% rate of interest, compounded annually) than the investment made later.

C)

91

the same facts as in response b, but the accumulation is only 10% greater. D)

92

that you will accumulate more in the additional 10 years than you do for the first 30 years. Answer :

93

D Diff: 2 Topic :

94


14)

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With an interest rate of 9%, $5,000 will grow to $10,000 in approximately A)

96

8 years. B)

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4 years. C)

98

12 years. D)

99

24 years. Answer :

100

A Diff: 1 Topic :

101

Rule of 72

15)

102

If you wish to double your money in 6 years, you must earn an interest rate of about A)

103

8%. B)

104

24%. C)

105

12%. D)

106

36%. Answer :

107

C Diff: 1 Topic :

108

Rule of 72

109

16)

110

At an interest rate of 10% it will take approximately how many years to double your investment?

A)

111

Less than five years B)

112

Between 7 and 8 years C)

113

Between 9 and 10 years D)

114

More than 10 years Answer :

115

B Diff: 1 Topic :

116

Rule of 72

17)

117

An annuity is A)

118

a sum received in the future. B)

119

a sum earned in the future but received now. C)

120

a series of unequal payments. D)

121

a series of equal payments. Answer :

122

D Diff: 1 Topic :

123

Annuities

18)

124

In relation to an ordinary annuity paid in any given year, an annuity due is A)

125

a larger amount. B)

126

a smaller amount. C)

127

an equal amount. D)

128

an unrelated amount. Answer :

129

A Diff: 1 Topic :

130

Annuities

19)

131

The future value of a $500 ordinary annuity received for three years is $________ , assuming an investment rate of 10%:

A)

132

1,655.00 B)

133

665.50 C)

134

1,820.50 D)

135

335.65 Answer :

136

A Diff: 3 Topic :

137

Annuities

20)

138

The future value of a $500 annuity due received for three years is $________, assuming an investment rate of 10%.

A)

139

1,655.00 B)

140

665.50 C)

141

1,820.50 D)

142

335.65 Answer :

143

C Diff: 3 Topic :

144

Annuities

145

21)

146

You will need $228,790 in 28 years to supplement your retirement funds. If you can earn 8% interest, you must save $________ each year. (Table or calculator required.)

A)

147

8,100 B)

148

6,300 C)

149

3,600 D)

150

2,400 Answer :

151

D Diff: 3 Topic :

152

Future value

22)

153

An ordinary annuity assumes ________-of-period payments, while an annuity due assumes ________-of-period payments.

A)

154

end; beginning B)

155

beginning; end C)

156

end; middle D)

157

beginning; middle Answer :

158

A Diff: 2 Topic :

159

Annuities

23)

160

Assuming a discount rate of 10%, the present value of $1,000 received one year from now is

A)

161

$1,100.00. B)

162

$1,900.00. C)

163

$909.09. D)

164

$990.00. Answer :

165

C Diff: 3 Topic :

166

Present value

24)

167

Assuming a discount rate of 10%, the present value of $1,000 received two years from now is

A)

168

$800.00. B)

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$826.45. C)

170

$899.90 D)

171

$900.00 Answer :

172

B Diff: 3 Topic :

173

Present value

25)

174

You will buy a lottery ticket. If you win, you have a choice of receiving $995,000 now or three equal end-of-year payments of $400,000. You should take the payments

A)

175

because $1,200,000 is greater than $995,000. B)

176

if you earn 20% or more on your investments. C)

177

if you earn 11% or more on your investments. D)

178

if you earn less than 10% on your investments. Answer :

179

D Diff: 3 Topic :

180

Present value

181

26)

182

An annuity contract will pay you $4,000 a year (end of year) for the next three years. Or, you can choose to receive $12,610 at the end of the third. Assuming that you can earn 8% on investments, you should

A)

183

choose to receive the $4,000 annuity payments. B)

184

choose to receive the $12,610 payment. C)

185

flip a coin to make the choice; each is equally attractive. D)

186

flip a coin to make the choice; each is equally unattractive. Answer :

187

A Diff: 3 Topic :

188

Annuities

27)

189

Which item below is not associated with goal planning? A)

190

Constructing a budget B)

191

Adjusting for inflation C)

192

Making goals concrete D)

193

Determining a savings schedule Answer :

194

A Diff: 1 Topic :

195

Planning

28)

196

Generally speaking, planners can usually seek higher return investments to meet A)

197

short-term goals. B)

198

long-term goals. C)

199

goals of any term. D)

200

dreams, but not goals. Answer :

201

B Diff: 2 Topic :

202

Planning

29)

203

A savings schedule with a zero ending balance means that A)

204

annual deposits are sufficient to meet all goals. B)

205

more savings are needed each year. C)

206

the most desirable schedule has been determined. D)

207

some goals will not be achieved. Answer :

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A Diff: 2 Topic :

209

Planning

30)

210

Young people most likely prefer a savings schedule with A)

211

a zero ending balance. B)

212

increasing annual deposits. C)

213

decreasing annual deposits. D)

214

negative balances in the early years. Answer :

215

B Diff: 2 Topic :

216

Planning

31)

217

Compounding is the process of increasing present value to future values. Answer :

218

TRUE Diff: 1 Topic :

219


220

32)

221

Discounting is the process of reducing future values to present values. Answer :

222


223

Present value

33)

224

The present value of $500 received at the end of each of the next three years is $1,243 (assuming a 10% interest rate).

Answer :

225


226

Present value

34)

227

You invest $100 today in a two-year certificate of deposit that pays a 10% annual interest rate compounded annually. At maturity, your CD will give you $120.

Answer :

228

FALSE Diff: 1 Topic :

229


35)

230

A simple interest calculation assumes you reinvest all interest earned in the investment. Answer :

231


232


36)

233

Looking at a future value of $1 table, you find the number 4.661 for 20 years and 8%. This means that a dollar invested today will grow to $4.661 at the end of 20 years.

Answer :

234


235

Future value

37)

236

Compounding is the process of increasing present value to future value. Answer :

237


238


38)

239

At an 8% rate, you must invest $5,000 to have $10,000 in about 6 years. Answer :

240


241

Future value

39)

242

At a 12% interest rate, $2,000 invested today will be worth approximately $8,000 in about 12 years.

Answer :

243


244

Future value

40)

245

You can double your investment in 6 years if you can earn 12% on your investments. Answer :

246


247

Rule of 72

41)

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John cashed in an annuity contract and received $10,000. John bought the contract 24 years ago for $5,000. These amounts indicate a contract rate of approximately 3%.

Answer :

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250


42)

251

The future value of $500 invested at the end of each of the next three years is $1,555 (assuming a 10% interest rate).

Answer :

252


253

Future value

43)

254

Given identical data, the future value of an ordinary annuity is greater than the future value of an annuity due.

Answer :

255


256

Annuities

44)

257

If the future value of an ordinary annuity is $8,000, the future value of an annuity due is $7,200 given a 10% interest rate.

Answer :

258


259

Annuities

45)

260

$500 invested at 8% at the beginning of each of the next four years will grow to approximately $2,433.

Answer :

261


262

Future value

46)

263

Given identical data, the future value of annuity due is always greater than the future value of an ordinary annuity.

Answer :

264


265

Annuities

47)

266

At any positive rate of interest, a future value will be greater than a present value. Answer :

267


268


48)

269

With a 10% interest rate, the present value of $100 received one year from today is $90.91. Answer :

270


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Present value

49)

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273


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Present value

50)

275

The higher the interest (discount) rate, the greater the present value of a future payment. Answer :

276


277

Present value

51)

278

Discounting is the reverse process of compounding. Answer :

279


280

Future value

52)

281


282


283


53)

284

The first step in goal planning is setting up a budget. Answer :

285


286

Planning

54)

287

An important part of goal planning is adjusting present values for expected inflation. Answer :

288


289

Planning

55)

290

Making goals concrete begins by determining their costs if they were undertaken today. Answer :

291


292

Planning

56)

293

Most young people prefer a savings schedule with decreasing annual deposits to the savings account.

Answer :

294


295

Planning

57)

296

Years with negative balances in the savings schedule implies that loans would be needed to achieve the goals.

Answer :

297


298

Planning

58)

299

You can earn 10%. If you hope to accumulate $20,000 in 4 years, you must make annual investments (end of period) of $3,918.

Answer :

300


301

Future value

59)

302

In goal planning, you generally match the savings vehicle to the time when the money is needed; for example, short-range goals are funded with low-risk investments.

Answer :

303


304

Planning

60)

305

An annual required savings amount confirms our computational accuracy but does not necessarily imply that our savings plan will use that amount each year.

Answer :

306


307

Planning

61)

308

Ideally, the ending balance in our savings plan is zero. Answer :

309


310

Planning

62)

311

If actual inflation rates exceed the rates assumed in our goal planning, the required annual savings amount can be reduced.

Answer :

312


313

Planning

63)

314

Highly volatile inflation rates and earning rates make goal planning a useless activity. Answer :

315


316

Planning

64)

317

Inflation decreases the purchasing power of money. Answer :

318


319

Planning

65)

320

Unplanned for inflation makes it easier to reach our financial goals. Answer :

321


322

Planning

66)

323

Generally, you can invest in higher-return assets for goals that are further out in the future. Answer :

324

TRUE Diff: 1 Topic:

325

Planning

326

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