Tutorial Questions from Lecture 2

Question 1

What happens to the future value of annuity if you increase the rate r? What happens to the
present value?

Question 2

What is the relationship between the present value, interest rate and discount period?

Question 3

An annuity:
a) is a debt instrument that pays no interest
b) is a stream of payments that vary with current market interest rates
c) is a level stream of equal payments trough time
d) has no value
e) none of the above

Question 4

You are borrowing money today at an 8% interest rate. You will repay the principal plus
all the interest in one lump sum of $6500 four years from today. How much are you
borrowing?
a) $4777.69
b) $1625.00
c) $5204.16
d) $5572.70
e) $6018.52

Question 5

One year ago you invested $3000. Today it is worth $3142.50. What rate of interest did
you earn?
a) 4.63%
b) 4.68%
c) 4.70%
d) 4.73%
e) 4.75%

Question 6

An investment offers $3,600 per year for 10 years. If the required return is 10%, what is
the value of the investment today?

Question 7

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First National Bank charges 12.2 percent compounded monthly on its business loans.
First United Bank charges 12.4 percent compounded semi-annually. As a potential
borrower, which bank would you go for a new loan?

FNB –> r = 12.2% (monthly)

0.122 12
= (1 + ) − 1 = 0.1291 = 12.91%
12
FUB -> r = 12.4% (semi-annually)
𝟎. 𝟏𝟐𝟒 𝟐
𝑬𝑨𝑹 = (𝟏 + ) − 𝟏 = 𝟎. 𝟏𝟐𝟕𝟖 = 𝟏𝟐. 𝟕𝟖%
𝟐
EAR – Equivalent annual rate

𝑁𝐼𝑅 𝑚
𝐸𝐴𝑅 = (1 + ) −1=
𝑚

m = number of compounds per year

Question 8

If the appropriate discount rate for the following cash flows is 9.75 percent per year, what
is the present value of the cash flows? What is the value in year 3?

Year Cash Flow

1 2,800
2 0
3 8,100

0 1 2 3
0 2800 0 8100

𝑪𝑭 𝟐𝟖𝟎𝟎 𝟎 𝟖𝟏𝟎𝟎
𝑷𝑽 = = + +
(𝟏 + 𝑹)𝒕 (𝟏 + 𝟎. 𝟗𝟕𝟓)𝟏 (𝟏 + 𝟎. 𝟗𝟕𝟓)𝟐 (𝟏 + 𝟎. 𝟗𝟕𝟓)𝟑
= 𝟖𝟔𝟕𝟖. 𝟓𝟗 𝒊𝒏 𝒚𝒆𝒂𝒓 𝟎

𝑭𝑽 = 𝑷𝑽(𝟏 + 𝑹)𝒕 = 𝟖𝟔𝟕𝟖. 𝟓𝟗 (𝟏. 𝟎𝟗𝟕𝟓)𝟑 = 𝟏𝟏𝟒𝟕𝟐. 𝟔 𝒊𝒏 𝒚𝒆𝒂𝒓 𝟑

Question 9

You are scheduled to receive $30,000 in two years. When you receive it, you will invest it
for six more years at 6.5% per year. How much will you have in eight years from now?

2 8
30000 ?

𝑭𝑽 = 𝑷𝑽(𝟏 + 𝑹)𝒕 = 𝟑𝟎𝟎𝟎𝟎(𝟏 + 𝟎. 𝟎𝟔𝟓)𝟔 = 𝟒𝟑𝟕𝟕𝟒. 𝟐𝟕

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Question 10

You expect to receive $10,000 at graduation in two years. You plan on investing it at 10%
until you have $120,000. How long will it take you to have this amount from now?

𝐹𝑉 120000
ln(𝑃𝑉 ) ln( 10000 )
𝑡= = = 26.071 𝑦𝑒𝑎𝑟𝑠 + 2 𝑦𝑒𝑎𝑟 𝑡𝑖𝑙𝑙 𝑦𝑜𝑢 𝑔𝑒𝑡 = 28.07𝑦𝑒𝑎𝑟𝑠
ln(1 + 𝑅) ln(1.1)

Question 11

Dinero Bank offers you a $40,000, seven year term loan at 9% annual interest rate. What
will your annual loan payment be?

Question 12

You are to make monthly deposits of $150 into a retirement account that pays 11 percent
interest rate compounded monthly. If your first deposit will be made one month from now,
how large will your retirement account be in 20 years?
If r is not annually / by number of compounding, / 12 in this case
t is not annually * 12

𝑪 𝟏𝟓𝟎
𝑭𝑽𝑨 = ((𝟏 + 𝑹)𝒕 − 𝟏) = ∗ ((𝟏. 𝟎𝟎𝟗𝟏𝟔𝟕)𝟐𝟒𝟎 − 𝟏) = 𝟏𝟐𝟗𝟎𝟎𝟎𝒊𝒔𝒉
𝑹 𝟎. 𝟎𝟎𝟗𝟏𝟔𝟕

Question 13

Beginning three months from now, you want to be able to withdraw $1,200 each quarter
from your bank account to cover college expenses over the next four years. If the account
pays 0.50 percent interest per quarter, how much do you need to have in your bank account
today to meet your expense needs over the next four years?

Question 14

You’ve just joined the investment banking firm of Dewey, Cheatum, and Howe. They’ve
offered you two different salary arrangements. You can have $80,000 per year for the next
two years, or you can have $60,000 per year for the next two years, along with a $35,000
signing bonus today. The bonus is paid immediately, and the salary is paid at the end of
each year. If the interest rate is 10 percent compounded monthly, which do you prefer?

Question 15

You are 15 year old today. Suppose your uncle makes the following promise: “Provided
that you abstain from smoking and all sorts of drugs, I promise that when you turn 18, I
will give you $10,000, when you turn 19 I will give you $15,000, and when you turn 20 I
will give you $20,000.
a) What is the value of this cash flow when you turn 18?
b) What is the value of this cash flow today?

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The appropriate discount rate is 5%.