chapter 3

Personal Finance: Turning Money into Wealth, 7e (Keown) Chapter 3 Understanding and Appreciating the Time Value of Money 3.1 Compound Interest and Future Values 1) Compounding is when the interest you have already earned on an investment earns interest. Answer: TRUE Diff: 2 Topic: Compounding AACSB: Analytical Thinking 2) Your money grows faster as the compounding period becomes longer. Answer: FALSE Diff: 3 Topic: Compounding AACSB: Analytical Thinking 3) An investment earning 12 percent interest per year should double in value in approximately four years. Answer: FALSE Diff: 2 Topic: Rule of 72 AACSB: Analytical Thinking 4) The present value of a financial asset is what you should be willing to pay today for that financial asset. Answer: TRUE Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 5) Time Value of Money calculations can be made much easier through the use of a financial calculator. Answer: TRUE Diff: 1 Topic: Calculator Skills AACSB: Information Technology 6) If you set your calculator to the "end" mode your calculator will assume cash flows occur at the end of each time period. Answer: TRUE Diff: 1 Topic: Calculator Skills AACSB: Information Technology

1 Copyright © 2016 Pearson Education, Inc.

7) The I/Y key on a financial calculator stores the information for the interest rate or the discount rate per period. Answer: TRUE Diff: 1 Topic: Calculator Skills AACSB: Information Technology 8) You currently have $11,167 in your savings account. What interest rate do you need to earn in order to have $20,000 in the account in 10 years? A) 6% B) 8% C) 10% D) There is not enough information to solve this question. Answer: A Diff: 2 Topic: Calculator Skills AACSB: Analytical Thinking 9) The ________ Principle states that a dollar today is worth more than a dollar in the future. A) Future value of money B) Discounted value of money C) Adjusted value of money D) Time value of money E) Annuity value of money Answer: D Diff: 1 Topic: Time Value of Money AACSB: Analytical Thinking 10) The current value in today's dollars of a future sum of money is called A) future value. B) adjusted value. C) compounded value. D) present value. E) discounted value. Answer: D Diff: 1 Topic: Present Value AACSB: Analytical Thinking

2 Copyright © 2016 Pearson Education, Inc.

11) The dollar value of an investment at some future point in time is also known as A) future value. B) present value. C) compounded annuity. D) the time value of money. E) calculated value. Answer: A Diff: 1 Topic: Future Value AACSB: Analytical Thinking 12) Allowing the interest that you earn on an investment to stay in the investment and to earn interest on the interest you have already earned is called what? A) The power of of present value B) The power of compound interest C) The power of simple interest D) The power of time E) The power of future value Answer: B Diff: 1 Topic: Compounding AACSB: Analytical Thinking 13) A one-time investment of $1,500 at a 10 percent annual rate of return yields $2,196 in two years. The $2,196 is known as the A) present value. B) compound value. C) principal plus interest. D) future value. E) annuity value Answer: D Diff: 3 Topic: Future Value AACSB: Analytical Thinking 14) John Madrid put $1,000 into a mutual fund yielding an 18% annual rate of return. Using the Rule of 72, calculate approximately how long it will take for the investment to double in value. A) Three years, four months B) Three years and seven months C) Four years D) Four years and four months E) Five years Answer: C Diff: 2 Topic: Rule of 72 AACSB: Analytical Thinking 3 Copyright © 2016 Pearson Education, Inc.

15) Samantha Jee put $3,000 into a mutual fund yielding a 12 percent annual rate of return. Using the Rule of 72, calculate approximately how long it will take for the investment to double in value. A) Two years B) Two years and four months C) Six years D) Seven years and four months Answer: C Diff: 2 Topic: Rule of 72 AACSB: Analytical Thinking 16) This helpful investment rule-of-thumb tells you approximately how many years it takes for a sum of money to double in size. A) Rule of compound interest B) Rule of 72 C) Rule of 100 D) Rule of future value E) Rule of annuity doubling Answer: B Diff: 1 Topic: Rule of 72 AACSB: Diverse and Multicultural Work Environments 17) By the Rule of 72, what annual interest rate would be required to turn $100 into $200 in approximately six years? A) 4% B) 8% C) 12% D) 16% Answer: C Diff: 2 Topic: Rule of 72 AACSB: Analytical Thinking 18) Suppose that you invested $100 in a bank account that earned an annual rate of return of 10%. How much would you have in that bank account at the end of 10 years? A) $259.37 B) $238.55 C) $293.74 D) $214.46 E) $279.23 Answer: A Diff: 2 Topic: Future Value AACSB: Analytical Thinking 4 Copyright © 2016 Pearson Education, Inc.

19) You have just placed $500 in a bank account that earns an annual rate of return of 6%. How much will you have in that bank account after 6 years? A) $652.48 B) $709.26 C) $787.66 D) $758.66 E) $801.68 Answer: B Diff: 2 Topic: Future Value AACSB: Analytical Thinking 20) As a future graduation present, you uncle has just placed $6,000 in a bank account that will earn an annual rate of return of 6%. How much will be in that account when you graduate in four years? A) $7,731.55 B) $6,752.56 C) $6,247.70 D) $7,790.63 E) $7,574.86 Answer: E Diff: 3 Topic: Future Value AACSB: Analytical Thinking 21) Suppose that you placed $500 in a bank account at the end of each year for the next 10 years. How much would be in that account at the end of the tenth year if the deposits earned an annual rate of return of 8% each year? A) $8,079.46 B) $5,400.00 C) $7,243.28 D) $6,355.04 E) $7,774.51 Answer: C Diff: 3 Topic: Future Value AACSB: Analytical Thinking

5 Copyright © 2016 Pearson Education, Inc.

22) Suppose that you want to create a "college fund" for your newborn child and place $300 in a bank account at the end of each of the next 20 years. If that account earns an annual rate of return of 7%, how much will be in that account at the end of the twentieth year? A) $13,420.00 B) $12,977.53 C) $13,178.20 D) $11,828.32 E) $12,298.65 Answer: E Diff: 3 Topic: Future Value AACSB: Analytical Thinking 23) Your great-uncle placed $500 a year in a bank account for your "college fund" for each of the last 18 years. How much is now in your college account (at the end of the eighteenth year) if your account earned an annual rate of return of 6%? A) $15,452.83 B) $15,175.17 C) $16,427.17 D) $15,413.80 E) $15,546.18 Answer: A Diff: 3 Topic: Future Value AACSB: Analytical Thinking 24) Which financial planning concepts should be helpful to a couple planning for how much money to start saving for their retirement? A) Reinvesting B) Compound interest C) Future values D) Present values E) All of the above Answer: E Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking

6 Copyright © 2016 Pearson Education, Inc.

25) A method by which one can compare cash flows across time—either as what a future cash flow is worth today (present value) or what an investment made today will be worth in the future (future value)—is called A) time-value of money. B) compounding. C) simple interest. D) opportunity cost. Answer: A Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 26) You have been saving toward the purchase of a new mountain bike. Five years ago, you placed $600 in a bank account, and you have since earned an annual rate of return of 12 percent. How much do you now have in your account? A) $1,057.41 B) $1,293.71 C) $978.70 D) $1,138.70 Answer: A Diff: 2 Topic: Future Value AACSB: Analytical Thinking 27) You have just remembered that four years ago you placed $1,000 in a bank account. If the bank was paying an annual rate of return of 8% during that time, how much should you have in your forgotten account? A) $1,253.03 B) $1,360.49 C) $1,321.92 D) $1,301.92 Answer: B Diff: 2 Topic: Future Value AACSB: Analytical Thinking 28) Your great-aunt wants to help with your college graduation party. She has just placed $5,000 dollars in a bank account that will earn an annual rate of return of 6%. If you graduate in four years, how much will be in your party account? A) $7,120.89 B) $6,142.96 C) $5,960.47 D) $6,312.38 Answer: D Diff: 3 Topic: Future Value AACSB: Analytical Thinking 7 Copyright © 2016 Pearson Education, Inc.

29) Suppose that you place $450 in a bank account each year for the next 20 years. How much would be in your bank account at the end of the twentieth year if the deposits earned an annual rate of return of 6% each year? A) $9,540.00 B) $10,876.31 C) $14,729.44 D) $16,553.52 Answer: D Diff: 3 Topic: Future Value AACSB: Analytical Thinking 30) Suppose that you want to create a "retirement party fund" for yourself and place $50 in a bank account for each of the next 20 years. If that account earns an annual rate of return of 7%, how much will be in your retirement party fund at the end of the twentieth year? A) $1,529.70 B) $2,679.22 C) $1,032.57 D) $2,049.77 Answer: D Diff: 3 Topic: Future Value AACSB: Analytical Thinking 31) Your daughter has been saving $500 a year for each of the last 10 years for her "sweet sixteen" party. How much is now in her party account (at the end of the tenth year) if she earned an annual rate of return of 6%? A) $6,590.40 B) $7,680.04 C) $5,300.00 D) $8,714.84 Answer: A Diff: 3 Topic: Future Value AACSB: Analytical Thinking 32) If your bank pays you interest in the form of an annual rate of return of 10% over each of the next five years, how much will your balance be if you make annual deposits of $400? A) $2,248.37 B) $2,644.20 C) $2,516.31 D) $2,442.04 Answer: D Diff: 3 Topic: Future Value AACSB: Analytical Thinking 8 Copyright © 2016 Pearson Education, Inc.

33) Using the Rule of 72, approximately how long will it take to double your money if you invest it at 8% compounded annually? A) 6 months B) 9 months C) 6 years D) 9 years E) It depends on the amount of the initial investment. Answer: D Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 34) Using the Rule of 72, if it will take approximately 12 years for your money to double, at what annually compounded interest rate is it invested? A) 6% B) 8% C) 9% D) 12% Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 35) You invest $1,000 at age 20 at an annual rate of return of 12%. By the time you are 62 you will have amassed approximately A) $47,040. B) $67,214. C) $116,723. D) $504,000. Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 36) Describe the effects and benefits of compound interest. Answer: Compounding interest means that interest earned on the principal of an investment or savings vehicle is reinvested and will itself earn interest. Should the interest earned be removed and not reinvested then you won't accumulate a very large amount. Diff: 2 Topic: Compounding AACSB: Analytical Thinking

9 Copyright © 2016 Pearson Education, Inc.

37) Why is the time value of money an important concept in financial planning? Answer: The time value of money allows us to see the relationship between time and the value of accumulated sums of money. We can clearly understand that starting a savings or retirement plan at a younger age will create much more wealth than waiting to start it at a later time. It also becomes clear that starting younger means saving a smaller monthly amount and having the option of skipping some months or years later if it becomes necessary to do so. Diff: 1 Topic: Time Value of Money AACSB: Reflective Thinking 38) What are some practical uses of present and future values? Answer: There are basically two practical uses for these values. Present values will tell you how much must be saved or invested annually to achieve a future financial goal. It also works for determining the monthly payment on a loan of a specified amount to be paid back in the future. Future values show the total future accumulated values of specified sums of money saved or invested now and into the future. Budgeting and financial planning would be very difficult if not impossible without the time value of money skills. Diff: 2 Topic: Time Value of Money AACSB: Reflective Thinking 39) A compound interest table is useful in solving a time value of money problem. Name the variables involved. Answer: The interest rate, the period of time involved, the sum of money involved, and the frequency of compounding are variables to consider when using a compound interest table. Diff: 1 Topic: Compounding AACSB: Analytical Thinking 3.2 Compounding and the Power of Time an Interest 1) A dollar received in the future is worth more than a dollar received today. Answer: FALSE Diff: 1 Topic: Time Value of Money AACSB: Analytical Thinking 2) The earlier you begin saving for your retirement, the easier it will be to reach your financial goals for retirement. Answer: TRUE Diff: 1 Topic: Time Value of Money AACSB: Reflective Thinking

10 Copyright © 2016 Pearson Education, Inc.

3) It is really pretty easy to create a valuable personal financial plan without understanding the time value of money principle. Answer: FALSE Diff: 2 Topic: Time Value of Money AACSB: Reflective Thinking 4) Charlie is starting to save for his retirement now at age 20. If inflation averages 4% annually until his retirement age and he earns an annual rate of return of 4% on his investments during this period, then he should be able to enjoy a very comfortable retirement when he is retired. Answer: FALSE Diff: 3 Topic: Inflation AACSB: Analytical Thinking 5) Small changes in the interest rate can have a dramatic impact on future values. Answer: TRUE Diff: 3 Topic: Time Value of Money AACSB: Diverse and Multicultural Work Environments 6) At the age of 20, James is starting to save for retirement. If inflation averages 4 percent annually until his retirement age and he earns an average annual rate of return of 13 percent on his investments during this period, he should be able to enjoy a comfortable retirement. Answer: FALSE Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 7) Two of the most important factors in reaching your financial goals are the return on your investments and the length of time you have until you need your money. Answer: TRUE Diff: 2 Topic: Time Value of Money AACSB: Reflective Thinking 8) Generally speaking, regularly saving a little money when you are young can result in a large final payoff. Answer: TRUE Diff: 2 Topic: Time Value of Money AACSB: Reflective Thinking

11 Copyright © 2016 Pearson Education, Inc.

9) It is not realistic for a 20-year-old to accumulate $1 million by the age of 65. Answer: FALSE Diff: 3 Topic: Time Value of Money AACSB: Reflective Thinking 10) Most people achieve comfortable retirements by postponing saving until after age 50, when they are able to save a large amount on a regular basis. Answer: FALSE Diff: 3 Topic: Time Value of Money AACSB: Reflective Thinking 11) Your money will grow or compound ________ as the number of compounding periods per year becomes ________. A) faster; smaller B) faster; larger C) slower; larger D) slower; compounded E) none of the above are correct Answer: B Diff: 3 Topic: Compounding AACSB: Analytical Thinking 12) Who will end up with the largest amount of money invested at an annual rate of return of 9% over the next 42 years? A) Jim saves $1,200 per year for the first 14 years and then stops putting any new money into the account for the remaining 28 years. B) Jeremy saves nothing for the first 14 years and saves $1,200 per year for the next 14 years and then puts no more money into the account during the last 14 years. C) Jerry saves nothing for the first 14 years and then saves $1,200 per year for the remaining 28 years. D) Joey saves nothing for the first 14 years and then saves $1,500 per year for 14 years then stops putting any new money into the account for the remaining 14 years. E) John saves nothing for the first 10 years and saves $1,500 per year for the remaining 32 years. Answer: A Diff: 3 Topic: Calculator Skills AACSB: Analytical Thinking

12 Copyright © 2016 Pearson Education, Inc.

13) Why should you care about the power of compounding and the time value of money? A) It is critical to obtaining your future financial goals. B) The sooner you start saving for retirement, the less you have to save each year. C) You may outlive your Social Security and employer's retirement plan. D) It is possible to build a large estate for yourself, spouse, and children. E) All of the above Answer: E Diff: 3 Topic: Compounding AACSB: Reflective Thinking 14) Is it possible to save $585,000 for retirement instead of $310,000 without requiring much more to be invested every month? A) Probably not with inflation working against you B) Depends upon the interest rate or return you earn on the investment as well as the number of years until retirement C) Absolutely not D) There is not enough information to answer this question. Answer: B Diff: 2 Topic: Time Value of Money AACSB: Diverse and Multicultural Work Environments 15) What is the annual interest rate earned on a deposit that grew from $250 to $502.84 over the last 5 years? A) 15% B) 13% C) 11% D) 9% Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 16) Suppose that you had deposited $100 in a bank account for each of the last 5 years. What annual interest rate is attached to this account if there is now (at the end of the fifth year) $758.92 in the account? A) 10% B) 16% C) 19% D) 21% E) 23% Answer: D Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 13 Copyright © 2016 Pearson Education, Inc.

17) What is the annual interest rate earned on a deposit that grew from $60 to $111.06 over the last 8 years? A) 14% B) 12% C) 8% D) 6% Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 18) One day as you were going through some old memorabilia, you discovered an old savings account in which you placed $100 twenty years ago. When you checked out the account, it currently had a balance of $320.71. What annual rate of interest did you earn? A) 12% B) 10% C) 8% D) 6% Answer: D Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking Arnold Diaz Arnold learned something very valuable as a teenager from his dad. He was told to invest $1,000 at 12% interest at age 20 and leave it alone until age 65. Arnold's dad knew that one strategy that wealthy people use is to exercise self-discipline to never touch this long-term plan. Arnold is very happy he applied his dad's advice. 19) Approximately how long will it take Arnold's savings to grow into $2,000? A) 60 months B) 5 years C) 8.5 years D) 6 years Answer: D Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking

14 Copyright © 2016 Pearson Education, Inc.

20) If he sticks to this plan, Arnold's savings will have grown to approximately ________ by age 62. A) $116,723 B) $163,987 C) $9,646 D) $1,125,945 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 21) If Arnold were to leave his money in the account until he was 68, by approximately what amount would the balance increase between his 62nd and 68th years? A) $113,667 B) $1,096,471 C) $160,457 D) $1,973 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 22) If his savings account had earned a more conservative 9% annual rate of return, Arnold's savings would be approximately ________ less by age 68. A) $4,132 B) $62,585 C) $167,805 D) $1,871,663 Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 23) Suppose the investment rate of return were 18%. At this rate, when would Arnold reach the $1,000,000 mark? A) at age 42 B) at age 54 C) at age 62 D) at age 68 Answer: C Diff: 3 Topic: Future Value AACSB: Analytical Thinking

15 Copyright © 2016 Pearson Education, Inc.

Enrique Martinez As a teenager, Enrique learned a valuable lesson from his dad, who told him to invest $1,000 at 8 percent interest at age 20 and leave the money alone until age 65. Enrique's dad knew that one strategy used by wealthy people is to exercise self-discipline and never touch a long-term savings plan. Enrique is happy to apply his dad's advice. 24) Approximately how long will it take Enrique's investment to grow into $2,000? A) Seventy-two months B) Six years C) Nine years D) Twelve years Answer: C Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 25) If he sticks to the plan, Enrique's savings will grow to approximately ________ by age 62. A) $25,339 B) $31,920 C) $4,660 D) $148,780 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 26) If Enrique leaves the money in the account until he is 68, by approximately what amount would the balance increase between his 62nd and 68th years? A) $14,872 B) $108,569 C) $8,291 D) $35,551 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking

16 Copyright © 2016 Pearson Education, Inc.

27) If his savings account earns a more aggressive 14 percent annual rate of return, Enrique's savings will be worth approximately ________ more by age 68. A) $4,145 B) $245,473 C) $498,596 D) $538,807 Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 28) Suppose the annual rate of return is 15 percent. At this rate, when will Enrique reach the $500,000 mark? A) Age 45 B) Age 58 C) Age 65 D) Age 70 Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 29) Describe the two factors that affect how much we need to save to achieve financial goals. Answer: The two variable factors that affect total accumulation are the interest rate received and the time period the savings/investment is allowed to accumulate. Increasing the interest rate and/or the period of time to accumulate will create a much larger end product. By decreasing either of these two factors, total accumulation will be decreased. Experiment with increasing either of these factors and the results will be both apparent and amazing. Diff: 2 Topic: Time Value of Money AACSB: Diverse and Multicultural Work Environments 30) List four reasons why you should care about the power of compounding and the time value of money. Answer: The concepts are critical to your efforts to achieve financial goals. The sooner you start saving for retirement, the less you have to save each year. You may outlive your Social Security benefits and employer retirement plans. The concepts will help you develop a large estate for yourself, spouse, and children. Diff: 3 Topic: Compounding AACSB: Analytical Thinking

17 Copyright © 2016 Pearson Education, Inc.

3.3 Present Value-What's It Worth in Today's Dollars? 1) The present value interest factor is the inverse of the corresponding future value interest factor. Answer: TRUE Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 2) Present value lets us compare dollar values from different time periods. Answer: TRUE Diff: 3 Topic: Time Value of Money AACSB: Reflective Thinking 3) The future value of a current investment earning a positive rate of return is always greater than the present value of the investment. Answer: TRUE Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 4) The discount rate is the interest rate used to bring ________ back to ________. A) current dollars; present dollars B) future dollars; present dollars C) current interest rate; present present interest rate D) future interest rate; present interest rate Answer: B Diff: 1 Topic: Present Value AACSB: Analytical Thinking 5) Which one of the following is the "enemy" of compound interest and makes it very difficult to reach your financial goals? A) Inflation B) Annuity factor C) Simple interest D) Compound frequency E) None of the above Answer: A Diff: 3 Topic: Compounding AACSB: Analytical Thinking

18 Copyright © 2016 Pearson Education, Inc.

6) What is the present value today of $150 that will be received in four years from now if the discount rate is 12%? A) $76.03 B) $95.33 C) $116.90 D) $105.60 E) $83.39 Answer: B Diff: 3 Topic: Present Value AACSB: Analytical Thinking 7) Rasheed can afford a monthly car payment of $550 for 72 months at an annual interest rate of 7.5 percent. Which of the following is closest to the amount he will be able to borrow for a new car? A) $3,984 B) $6,550 C) $31,810 D) $49,818 Answer: C Diff: 3 Topic: Time Dimension of Investing AACSB: Analytical Thinking 8) What is the present value of an IOU for $1,000 due to be paid in two years, if the discount rate is 8%? A) $857.34 B) $766.40 C) $885.00 D) $683.26 E) $810.77 Answer: A Diff: 3 Topic: Present Value AACSB: Analytical Thinking 9) What is the price you would be willing to pay today for an IOU for $500 due in one year if you want to earn at least 16%? A) $480.00 B) $431.03 C) $450.00 D) $395.33 E) $418.23 Answer: B Diff: 3 Topic: Present Value AACSB: Analytical Thinking 19 Copyright © 2016 Pearson Education, Inc.

10) At the end of each year for ten years you deposit $750 in an account that earns an annual rate of return of 12%. What is the present value of these deposits? A) $4,329.39 B) $5,241.48 C) $3,161.55 D) $4,237.67 E) $4,482.63 Answer: D Diff: 3 Topic: Present Value AACSB: Analytical Thinking 11) Sam's uncle promised to give him $7,000 when he graduates from college three years from now. Assuming an interest rate of 8 percent compounded annually, what is the value of Sam's gift right now? A) $5,504.22 B) $5,510.78 C) $5,556.83 D) $5,555.55 Answer: C Diff: 3 Topic: Present Value AACSB: Analytical Thinking 12) Someone has offered you the opportunity to purchase an IOU. The IOU will pay back a total of $500 in three years. How much would you be willing to pay for that IOU today if you want to earn an annual rate of return of 16%? A) $320.33 B) $422.63 C) $292.63 D) $380.45 Answer: A Diff: 3 Topic: Present Value AACSB: Analytical Thinking

20 Copyright © 2016 Pearson Education, Inc.

13) What is the maximum that you would be willing to loan your brother for a $100 IOU if he promises to pay you back at the end of the year? You want to earn an annual rate of return of 12%. A) $82.00 B) $89.29 C) $92.73 D) $88.00 Answer: B Diff: 3 Topic: Present Value AACSB: Analytical Thinking 3.4 Annuities 1) A perpetuity is an annuity that continues forever. Answer: TRUE Diff: 2 Topic: Annuity AACSB: Analytical Thinking 2) A compound annuity involves depositing or investing an equal sum of money at the end of each time period for a certain number of time periods and allowing it to grow. Answer: TRUE Diff: 1 Topic: Annuity AACSB: Diverse and Multicultural Work Environments 3) An annuity is a series of unequal dollar payments coming at the end of each time period for a specified number of time periods. Answer: FALSE Diff: 2 Topic: Annuity AACSB: Diverse and Multicultural Work Environments 4) With a mortgage loan of $150,000 at an annual percentage rate of 6% for 30 years, you will pay over $150,000 in interest before your loan ends. Answer: TRUE Diff: 3 Topic: Compounding AACSB: Analytical Thinking 5) With a 30-year mortgage loan of $100,000 at an annual interest rate of 7 percent, you will pay less $135,000 in interest before your loan ends. Answer: FALSE Diff: 3 Topic: Compounding AACSB: Analytical Thinking 21 Copyright © 2016 Pearson Education, Inc.

6) In an amortized loan the earlier payments have a larger portion of the payment going to pay interest and a smaller portion of the payment to pay down the principle. Answer: TRUE Diff: 3 Topic: Amortized Loan AACSB: Analytical Thinking 7) A compound annuity uses the principles of A) reinvesting and present value. B) compound interest and future value. C) reinvesting and compound interest. D) compound interest and present value. E) amortization and reinvesting. Answer: C Diff: 3 Topic: Annuity AACSB: Analytical Thinking 8) A series of equal dollar payments at the end of each period for "x" number of time periods is A) an annuity. B) a complex annuity. C) an annuity due. D) a deferred annuity. E) an equal installment annuity. Answer: A Diff: 1 Topic: Annuity AACSB: Analytical Thinking 9) What is the present value of $500 received at the end of each of the next five years worth to you today at the appropriate discount rate of 6 percent? A) $1,105 B) $1,850 C) $2,106 D) $2,778 Answer: C Diff: 3 Topic: Annuity AACSB: Analytical Thinking

22 Copyright © 2016 Pearson Education, Inc.

10) What is the present value of an annual payment of $1,500 discounted back 15 years at an annual rate of return of 3%? A) $10,663.87 B) $12,334.56 C) $13,449.87 D) $17,906.90 Answer: D Diff: 3 Topic: Annuity AACSB: Analytical Thinking 11) What is the present value of an annual payment of $3,600 discounted back 12 years at an annual rate of return of 5 percent? A) $12,977.19 B) $31,907.71 C) $45,360.00 D) $57,301.66 Answer: B Diff: 3 Topic: Annuity AACSB: Analytical Thinking 12) What is the future value of a series of $500 annual payments received at the end of each of the next 5 years' worth if they are invested at an annual rate of return of 6%? A) $1,223.44 B) $2,176.65 C) $2,818.50 D) $3,309.76 Answer: C Diff: 3 Topic: Annuity AACSB: Analytical Thinking 13) What is the future value of a stream of $800 annual payments worth to the investor at the end of 10 years if these payments are invested at an annual rate of return of 8.5%? A) $11,868.08 B) $12,195.22 C) $13,334.90 D) $13,667.88 Answer: A Diff: 3 Topic: Annuity AACSB: Analytical Thinking

23 Copyright © 2016 Pearson Education, Inc.

14) What is the present value of a $1,000 payment at the end of each of the next 10 years discounted back to the present at 5%? A) $5,098 B) $7,722 C) $8,775 D) $9,112 Answer: B Diff: 3 Topic: Annuity AACSB: Analytical Thinking 15) Suppose that you want to purchase a car today. You can afford payments of $400 per month and want to pay the loan back over the next five years. Assuming no down payment is required, how much can you borrow if the bank will charge you an annual percentage rate of 12% compounded monthly? A) $16,726.68 B) $18,220.18 C) $24,667.87 D) $25,008.90 E) $17,982.02 Answer: E Diff: 3 Topic: Present Value AACSB: Analytical Thinking 16) How much can you borrow today if you can make payments of $3,600 a year for the next five years and the interest rate is 10%? A) $13,646.83 B) $12,235.32 C) $18,978.36 D) $15,797.84 E) $17,949.67 Answer: A Diff: 3 Topic: Present Value AACSB: Analytical Thinking

24 Copyright © 2016 Pearson Education, Inc.

17) Sly's Used Cars just sold you a clunker (you need it to get to class on time). You financed the $4,728.48 purchase price for 24 months. They said your payment would be $250. What interest rate did they charge you (assume monthly compounding)? A) 10% B) 12% C) 16% D) 19% E) 24% Answer: E Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 18) What would be the interest rate on a loan of $9,981.78 that you paid off with annual payments of $2,500 for each of the next five years? A) 8.0% B) 10% C) 15% D) 21% E) 26% Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 19) You just purchased a premier lot in an exclusive neighborhood for your future home. The lot cost $50,000, an amount you financed with a 96-month loan. If your interest rate is 9.25 percent compounded monthly, which of the following is closest to your monthly payment? A) $744.55 B) $853.60 C) $767.23 D) $739.02 E) $810.92 Answer: D Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking

25 Copyright © 2016 Pearson Education, Inc.

20) If Monica invests $15,750 at 8 percent annual interest, how much would she have after eight years? A) $29,152.15 B) $17,010.08 C) $32,354.22 D) $39,678.92 Answer: A Diff: 3 Topic: Future Value AACSB: Analytical Thinking 21) How much did you borrow if your annual payments are $5,000 for the next seven years and the interest rate is 9%? A) $25,164.76 B) $36,002.17 C) $19,140.20 D) $27,797.84 Answer: A Diff: 3 Topic: Present Value AACSB: Analytical Thinking 22) Suppose that you want to purchase some land to build a homestead in the future. You can afford payments of $5,000 each year and want to pay the loan back over the next 20 years. Assuming no down payment is required, how much can you borrow if the bank will charge you an annual interest rate of 12%? A) $100,985.45 B) $48,231.47 C) $37,347.22 D) $160,262.21 Answer: C Diff: 3 Topic: Present Value AACSB: Analytical Thinking 23) What would be the interest rate on a loan of $39,927.10 that you paid off with annual payments of $10,000 for each of the next five years? A) 8% B) 10% C) 15% D) 21% E) 26% Answer: A Diff: 3 Topic: Present Value AACSB: Analytical Thinking 26 Copyright © 2016 Pearson Education, Inc.

24) Car loans and mortgage loans are typical annuities in the form of A) maturity loans. B) compound loans. C) amortized loans. D) payment loans. Answer: C Diff: 2 Topic: Amortized Loan AACSB: Analytical Thinking 25) A perpetuity is an annuity where the payments A) stop at maturity. B) are delayed until maturity. C) increase due to inflation. D) never stop. E) accrue until maturity. Answer: D Diff: 2 Topic: Perpetuity AACSB: Analytical Thinking 26) You just purchased a vacant lot for your future son-in-law's home for $30,000. You financed that amount over 120 months. What would your monthly payment be if your interest rate was 12% compounded monthly? A) $430.41 B) $389.21 C) $231.22 D) $189.02 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 27) When a loan is paid off in equal installments, this is called a(n) ________ loan. A) amortized B) discounted C) balloon D) reverse annuity E) none of the above Answer: A Diff: 1 Topic: Amortized Loan AACSB: Analytical Thinking

27 Copyright © 2016 Pearson Education, Inc.

28) Consider that you are paying back a fully amortized loan. Which of the following statements is most correct? A) Later loan payments involve larger amounts of principal repayment. B) The actual loan payments vary from year to year. C) After the last loan payment is made, there is still a large principal repayment remaining. D) Early loan payments include smaller amounts of interest payments. E) None of the above statements are true. Answer: A Diff: 3 Topic: Amortized Loan AACSB: Analytical Thinking 29) Suppose you borrowed $12,000 at an annual rate of 6 percent interest to buy a car and wish to repay it in five equal payments at the end of each of the next five years. Which of the following is the closest to the amount of each of these payments? A) $2,364 B) $2,849 C) $2,544 D) $2,436 Answer: B Diff: 3 Topic: Amortized Loan AACSB: Analytical Thinking 30) Assuming that you can afford a car payment of $400 for 36 months, which of the following is closest to the annual interest rate you would need on a loan to borrow $12,000 for a new car? A) 10.99 percent B) 11.26 percent C) 12.25 percent D) 12.99 percent Answer: C Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 31) Jah-Malya can afford a car payment of $400 per month for 48 months at an annual rate of 8.25 percent interest. Which of the following is closest to the amount she will be able to borrow for a new car? A) $16,306 B) $4,741 C) $22,656 D) $12,997 Answer: A Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 28 Copyright © 2016 Pearson Education, Inc.

32) Mark borrows $15,000 to buy a new car. His loan has an annual interest rate of 6.5%, compounded monthly, and his monthly payment is $293.49. How much will he have paid in interest when he has finished repaying his loan in 60 months? A) $43.49 B) $1,575.50 C) $2,609.40 D) $17,609.40 Answer: C Diff: 3 Topic: Amortized Loan AACSB: Analytical Thinking 33) Mark borrows $15,000 to buy a new car. His loan has an interest rate of 6.5%, compounded monthly, and his monthly payment is $293.49. If instead his loan had an interest rate of 8%, how much more would he have paid in interest by the time he finished repaying his loan in 60 months? A) $225.00 B) $304.15 C) $639.60 D) $3,249.00 Answer: C Diff: 3 Topic: Amortized Loan AACSB: Analytical Thinking Adrian Clemons Adrian, a single man who wants to buy a house in five years, read an article that recommended a down payment of 20 percent. With a large income and little debt, Adrian can afford to save a substantial amount of money every month. He is asking you for advice to help him reach his goal. 34) Adrian found a nice house today that is selling for $150,000. Assuming an inflation rate of 5 percent in the local real estate market, how much will this house sell for in five years? A) $187,500 B) $191,442 C) $204,650 D) $157,500 Answer: B Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking

29 Copyright © 2016 Pearson Education, Inc.

35) Assume that Adrian will need $30,000 for his 20 percent down payment in five years. If he locates an investment with a 9 percent rate of return that compounds annually, which of the following is closest to the amount that he will have to save each year? A) $6,003 B) $4,884 C) $5,187 D) $5,013 Answer: D Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 36) It is now five years later, and Adrian has saved enough money for a 20 percent down payment on a house. He will have to borrow $135,000 in a 30-year loan with an annual interest rate of 6 percent compounded monthly. What will his monthly mortgage payment be? A) $1,199.55 B) $809.39 C) $779.98 D) $397.50 Answer: B Diff: 2 Topic: Time Value of Money AACSB: Analytical Thinking 37) Define an amortized loan and give two common examples. Answer: An amortized loan is a loan paid off in equal installments. The loan amount is paid back by spreading or amortizing the payments out over a certain time period based on a specific interest rate. Two common examples are auto loans and home mortgages. Diff: 1 Topic: Amortized Loan AACSB: Diverse and Multicultural Work Environments 38) List at least five common examples of annuities. Answer: a one year lease on an apartment, your five year car loan, your parents' mortgage payments, monthly savings to reach a college education expense goal, a monthly paycheck if you are on salary, and constant monthly contributions to retirement plans are all examples of annuities. Diff: 1 Topic: Annuity AACSB: Reflective Thinking

30 Copyright © 2016 Pearson Education, Inc.

39) For someone who has $100,000 to save for 20 years, would a 4% Certificate of Deposit that compounds annually be a better deal than a 3.94% Certificate of Deposit that compounds quarterly? Why? Answer: With the 4% annual compounding, your $100,000 would compound into $219,112.31. There would be 20 compounding periods at 4% per year and the interest would be calculated at the end of every year. Your $4,000 in interest from year one would not earn any interest until the end of year two ($160). With the quarterly compounding your interest would start earning interest itself starting with the second quarter of year one. There would be a total of 80 compounding periods (4 quarters per year times 20 years) and this would mean that even with the lower interest rate, your money would grow to $219,053.19 for a slight difference of $59.12! Diff: 3 Topic: Time Value of Money AACSB: Analytical Thinking 40) What recommendations would you offer to someone who is trying to break poor financial habits and save money in order to achieve his or her financial goals? Answer: Recommendation one: First, gain an understanding of how compounding works–that as the number of years and the interest rate you earn go up, so does the future value of an investment. Recommendation two: Think of savings as a "snowball effect." You earn interest on your initial investment, and those interest earnings and the initial investment both continue to earn interest. When these earnings are extended over multiple decades, your money can really add up. In other words, you want to start investing as soon as possible. Recommendation three: Pay yourself–your future self, that is–first. To make this process as painless as possible, automate the payments so that when your paycheck is deposited into your bank account, a percentage is automatically transferred to a separate investment account–perhaps your retirement account. Or ask your employer's payroll department about a mandatory payroll deduction. It is much easier to save the money that you never really see! Diff: 3 Topic: Financial Goals AACSB: Reflective Thinking

31 Copyright © 2016 Pearson Education, Inc.