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Reasons for saving and investing include need for funds to meet emergencies retirement income desire to leave an estate for children
1 and 2 1 and 3 2 and 3 all of these choices D Many investments have common characteristics including 1. existence of secondary markets 2. risk 3. potential for capital gains 1 and 2 1 and 3 2 and 3 all of these choices D
a. b. c. d.
ANS: 3. a. b. c. d.
Risk depends solely on price fluctuations should be maximized to increase returns is reduced through specialization refers to the uncertainty of returns D
ANS: 4. a. b. c. d.
Diversification reduces systematic risk unsystematic risk market risk purchasing power risk B
ANS: 5. a. b. c. d.
Unsystematic risk is increased through diversification is reduced when markets fluctuate less is affected by the nature of how a firm finances its operations increases during periods of volatile interest rates C Sources of risk to the investor include loss of income when funds are reinvested fluctuations in security markets the financing decisions of the firm 1 and 2 1 and 3 2 and 3 all of these choices D
ANS: 6. 1. 2. 3. a. b. c. d.
An investor expects the price of a stock to double after eight years. What is the expected annual rate of growth? (1 + g)8 = 2
ANS: $1(1 + g)8 = 2
Using the interest table for the future value of $1, the growth rate is approximately 9 percent. (PV = 1; FV = 2; N = 8; PMT = 0; I = ? = 9.05.) The problem may also be solved as follows: (1 + g)8 = 2 g = 2.125 1 = 9.05% 8. You wish to have $100,000 after ten years to buy a nice boat. How much must you invest at the end of each year if you earn 8 percent annually on your funds? ANS: X(14.486) = $100,000 X = $100,000/14.486 = $6,903.22 (PV = 0; N = 10; I = 8; FV = 100000; PMT = ? = 6903.) 9. An investment offers $10,000 at the end of each year for ten years. (a) If you can earn 10 percent annually, what is this investment worth today? (b) If you do not spend the annual payment but invest it at 10 percent, how much will you have after the ten years have lapsed? ANS: a.
X = $61,450 (N = 10; I = 10; PMT = 10000; FV = 0; PV = ? = 61446.) b. $10,000(15.937) = $159,370 (PV = 0; N = 10; I = 10; PMT = 10000; FV = ? = 159374.)
10. A piece of rental property will generate $10,000 a year for five years, $12,000 for the next five years, and then be sold at the end of the tenth year for $100,000. If you can earn 10 percent on your funds, what is the maximum you should pay for the property? ANS: Maximum price: $10,000(3.791) 12,000(3.791)(.621) 100,000(.386)
= $ 37,910 = 28,251 = 38,600 $104,761
(Since the cash inflows vary, this problem requires using a calculator that accepts annual unequal payments.)