Self-test Questions

The self-test questions are intended to help you assess your understanding of the topics and concepts presented in the chapter. The questions are graded based on completion. However, responses should demonstrate an effort to thoroughly answer the questions while applying the concepts presented in the chapter. Points will be deducted for questions not answered or if you do not provide accurate responses for questions which include definitions or equations as presented in the chapter. All questions are worth one point unless otherwise stated.


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Chapter 5

Time Value of Money

Self-test Questions


  1. Do time lines deal only with years, or can other time periods be used?


  1. Explain why this statement is true: A dollar in hand today is worth more than a dollar to be receive next year.


  1. What is compounding?


  1. What is the difference between simple interest and compound interest?


  1. What is discounting?


  1. How does the present value of a future payment change as the time to receipt is lengthened? As the interest rate increases?


  1. What is the difference between an ordinary annuity and an annuity due?


  1. Why would you prefer to receive an annuity due for $10,000 per year for 10 years than an otherwise similar ordinary annuity?


  1. Why does an annuity due always have a higher future value than an ordinary annuity?


  1. Why does an annuity due have a higher present value than a similar ordinary annuity?


  1. Would a typical common stock provide cash flows more like an annuity or more like an uneven cash flow stream? Explain.


  1. Why are we more likely to need to calculate the PV of cash flow streams than the FV of streams?


  1. Would you rather invest in an account that pays 7% with annual compounding or 7% with monthly compounding? Would you rather borrow at 7% and make annual or monthly payments? Why?


  1. Define the following terms:
  • Annual percentage rate (APR) or nominal interest rate –
  • Effective annual rate (EFF%) –


  1. A bank pays 5% with daily compounding on its savings accounts. Should it advertise the nominal or effective rate if it is seeking to attract new deposits? Explain.



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