# Chapter 07 Interest Rates and Present Value

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1 Chapter 07 Interest Rates and Present Value Multiple Choice Questions 1. The percentage of a balance that a borrower must pay a lender is called the a. Inflation rate b. Usury rate C. Interest rate d. Monetary index 2. In a market for money, it is typically the case that we use the in a supply and demand model. a. Inflation rate B. Interest rate c. Wage rate d. Monetary index 3. In a supply and demand model for the market for money, we typically use the to look at savers' behavior a. The demand curve B. The supply curve c. The production possibilities frontier d. The surplus curve 4. In a supply and demand model for the market for money, we typically use the to look at borrowers' behavior A. The demand curve b. The supply curve c. The production possibilities frontier d. The surplus curve 7-1

2 Use Figure 7.1 to answer questions 5-8: Figure Assuming that Figure 7.1 is a market for money that can be borrowed or saved, Box 1 is a. "\$" for the amount borrowed/saved b. "\$*" for the equilibrium amount borrowed/saved C. "r" for interest rate d. "r*" for equilibrium interest rate 6. Assuming that Figure 7.1 is a market for money that can be borrowed or saved, Box 3 is a. "\$" for the amount borrowed/saved b. "\$*" for the equilibrium amount borrowed/saved c. "r" for interest rate D. "r*" for equilibrium interest rate 7-2

3 7. Assuming that Figure 7.1 is a market for money that can be borrowed or saved, Box 4 is a. "\$" for the amount borrowed/saved B. "\$*" for the equilibrium amount borrowed/saved c. "r" for interest rate d. "r*" for equilibrium interest rate 8. Assuming that Figure 7.1 is a market for money that can be borrowed or saved, Box 6 is A. "\$" for the amount borrowed/saved b. "\$*" for the equilibrium amount borrowed/saved c. "r" for interest rate d. "r*" for equilibrium interest rate 9. If people (who used to neither borrow nor save) are now saving for their retirement then this will cause the A. Supply for loanable funds to increase b. Demand for loanable funds to increase c. Supply for loanable funds to decrease d. Demand for loanable funds to decrease 10. If people (who used to neither borrow nor save) are now saving for their retirement then this will cause the equilibrium interest rate a. To rise B. To fall c. To fluctuate wildly d. To remain constant 11. If people (who used to neither borrow nor save) are now borrowing to put their kids through college then this will cause the a. Supply for loanable funds to increase B. Demand for loanable funds to increase c. Supply for loanable funds to decrease d. Demand for loanable funds to decrease 7-3

4 12. If people (who used to neither borrow nor save) are now borrowing to put their kids through college then this will cause the equilibrium interest rate A. To rise b. To fall c. To fluctuate wildly d. To remain constant 13. In the market for loanable dollars, an increase in the profitability of investments overall will be revealed in a. An increase in the supply of loanable dollars B. An increase in the demand for loanable dollars c. A decrease in the supply of loanable dollars d. A decrease in the demand for loanable dollars 14. The difference between nominal and real interest rates is that a. Real interest rates are almost always greater than nominal interest rates B. Real interest rates are what you get after having adjusted nominal rates for inflation c. Nominal interest rates are what lenders receive and real interest rates are what borrowers pay d. Nominal interest rates are what borrowers pay and real interest rates are what lenders receive 15. When evaluating whether or not to make an investment one should focus on the because doing so takes into account anticipated inflation. a. Nominal interest rate b. Exchange rate C. Real interest rate d. Junk bond rate 7-4

5 16. If the inflation rate is 3% and the real interest rate is 4%, then the nominal interest rate is a. 1% b. 3% C. 7% d. 12% 17. If the inflation rate is 2% and the real interest rate is 1%, then the nominal interest rate is a. -1% b. 1% c. 2% D. 3% 18. If the inflation rate is 5% and the real interest rate is 4%, then the nominal interest rate is a. -1% b. 1% C. 9% d. 20% 19. If the inflation rate is 6% and the real interest rate is 4%, then the nominal interest rate is a. 2% b. -2% c. 6% D. 10% 20. If the inflation rate is 3% and the nominal interest rate is 4%, then the real interest rate is A. 1% b. 3% c. 7% d. 12% 7-5

6 21. If the inflation rate is 2% and the nominal interest rate is 1%, then the real interest rate is A. -1% b. 1% c. 2% d. 3% 22. If the inflation rate is 5% and the nominal interest rate is 4%, then the real interest rate is A. -1% b. 1% c. 9% d. 20% 23. When evaluating a business decision, an economist will often resort to the use of present value because a. The profits may not be large enough to warrant the time and attention of the investor B. The investment occurs in one time period and the profits in another c. The investment is often in one currency and the profits in another d. The investment is often under one set of managers and the profits under another 24. To determine whether an investment makes sense a business will compute the net present value and if the result is a. Negative they will make the investment B. Positive they will make the investment c. Positive they will not make the investment unless the interest rate rises d. Positive they will not make the investment regardless of the change in interest rates 7-6

7 25. If a business makes the determination that an investment makes sense at the current interest rate but before they can act the interest rates rises A. They will have to recalculate whether it still makes sense b. It will only make the situation better so they will clearly make the investment c. It will cause them to not make the investment regardless of the increase d. They will go ahead with the investment because interest rates have nothing to do with whether an investment makes sense 26. If a business makes the determination that an investment makes sense at the current interest rate but before they can act the interest rates fall a. They will have to recalculate whether it still makes sense B. It will only make the situation better so they will clearly make the investment c. It will cause them to not make the investment regardless of the decrease d. They will go ahead with the investment because interest rates have nothing to do with whether an investment makes sense 27. If the interest rate is positive, the present value of a stream of payments is a. Greater than the sum of the actual payments over time B. Less than the sum of the actual payments over time c. Equal to the sum of the actual payments over time d. Unrelated to the stream of actual payments over time 28. If the interest rate is positive, the present value of \$1000 to be received in ten years is A. Less than \$1000 b. Greater than \$1000 c. Equal to \$1000 d. Either greater than \$1000 or less than \$1000, depending upon the interest rate 7-7

9 34. If payments of \$1000 are to be received every year for 20 years and if the interest rate is positive, the present value of this stream will A. Exceed \$1000x20 (\$20,000) b. Equal \$1000x20 (\$20,000) c. Be less than \$1000x20 (\$20,000) d. Increase as the interest rate increases 35. If you know that you can afford a \$500 per month car payment for the next 48 months, the interest rate is positive and you have found a car dealer who will agree to a zero down payment you will a. Be able to afford a \$25,000 car (which is more than \$500x48) b. Be able to afford a \$24,000 car (which is exactly \$500x48) C. Be able to afford something less than a \$24,000 car d. Be able to finance a more expensive car when the interest rate is high 36. If you have a business opportunity that is pretty much a sure thing that will require you to borrow \$1,000,000, but will return to you \$200,000 a year in profit for ten years, this is a. A wise investment regardless of interest rates b. An unwise investment regardless of interest rates C. An investment which depends on the interest rate that must be paid on the loan d. An investment which will be more attractive when the interest rate is high 37. If you are anticipating having to pay \$100,000 to a lender 10 years from now and the interest rate rises, the present value of this sum A. Falls b. Rises c. Remains unchanged d. First rises, then falls 7-9

10 38. If you are anticipating having to pay \$100,000 to a lender 10 years from now and the interest rate falls, the present value of this sum a. Falls B. Rises c. Remains unchanged d. Becomes more uncertain 39. If your broker tells you that a trust to which you are a beneficiary has changed and instead of getting \$5000 per year starting next year you will be getting \$4000 per year starting next year, the present value to you has A. Fallen b. Risen c. Remained unchanged d. Necessarily become more predictable 40. If your broker tells you that a trust to which you are a beneficiary has changed and instead of getting \$5000 per year starting next year you will be getting \$6000 per year starting next year the present value to you has a. Fallen B. Risen c. Remained unchanged d. Necessarily become more predictable 41. If your broker tells you that a trust to which you are a beneficiary has changed and instead of getting \$5000 per year starting next year you will be getting \$6000 per year but it will be starting the year after next the present value to you has a. Fallen b. Risen c. Remained unchanged D. Might have either fallen or risen, depending on the interest rate 7-10

11 42. The possibility that an investor will not receive full payment is called a. An advance b. Credit c. The index problem D. Risk 43. The form of risk to the lender associated with a borrower not paying their debt is called a. Market risk B. Default risk c. Overall risk d. Complete risk 44. The form of risk to the investor associated with the asset unexpectedly falling in price is called A. Market risk b. Default risk c. Overall risk d. Complete risk 45. The reward investors receive for accepting the probability that they will not be fully paid as agreed or as anticipated is called the a. Risk adjustment B. Risk premium c. Interest rate d. Real interest rate 46. The relationship between the rate of return earned on a bond and the length of time until the bond matures is called the a. Interest rate b. Real interest rate c. Calendar D. Yield curve 7-11

12 47. The interest rate at which the present value of costs equals the present value benefits is the a. Coupon interest rate b. Yield to maturity C. Internal rate of return d. Market interest rate 48. If an investment requires payment of \$10,000 now and promises to return a single payout of \$15,000 one year from now, the net present value of the investment at an interest rate of 12% is approximately A. \$3,393 b. \$5,000 c. \$10,000 d. \$13, If an investment requires payment of \$5,000 now and promises to return a single payout of \$15,000 one year from now, the net present value of the investment at an interest rate of 10% is approximately a. \$3,636 B. \$8,636 c. \$10,000 d. \$13, If an investment requires payment of \$10,000 now and promises to return a payout of \$15,000 one year from now and another payout of \$15,000 two years from now, the net present value of the investment at an interest rate of 8% is approximately a. \$5,000 b. \$11,749 C. \$16,749 d. \$26,

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