## Week 2 Questions

### What is an opportunity cost rate?

Define each of the following terms:

PV; I; INT; FVN; PVAN; FVAN; PMT; M; INOM

Opportunity cost rate

Annuity; lump-sum payment; cash flow; uneven cash flow stream

Ordinary (or deferred) annuity; annuity due

Perpetuity; consol

Outflow; inflow; time line; terminal value

Compounding; discounting

Annual, semiannual, quarterly, monthly, and daily compounding

Effective annual rate (EAR or EFF%); nominal (quoted) interest rate; APR; periodic rate

Amortization schedule; principal versus interest component of a payment; amortized loan

(4-2)
What is an opportunity cost rate? How is this rate used in discounted cash flow analysis, and where is it shown on a time line? Is the opportunity rate a single number that is used to evaluate all potential investments?

(4-3)
An annuity is defined as a series of payments of a fixed amount for a specific number of periods. Thus, \$100 a year for 10 years is an annuity, but \$100 in Year 1, \$200 in Year 2, and \$400 in Years 3 through 10 does not constitute an annuity. However, the entire series does contain an annuity. Is this statement true or false?

(4-4)
If a firm’s earnings per share grew from \$1 to \$2 over a 10-year period, the total growth would be 100%, but the annual growth rate would be less than 10%. True or false? Explain.

(4-5)
Would you rather have a savings account that pays 5% interest compounded semiannually or one that pays 5% interest compounded daily? Explain.

(5-1)
Define each of the following terms:

Bond; Treasury bond; corporate bond; municipal bond; foreign bond

Par value; maturity date; coupon payment; coupon interest rate

Floating-rate bond; zero coupon bond; original issue discount bond (OID)

Call provision; redeemable bond; sinking fund

Convertible bond; warrant; income bond; indexed bond (also called a purchasing power bond)

Current yield (on a bond); yield to maturity (YTM); yield to call (YTC)

Indentures; mortgage bond; debenture; subordinated debenture

Development bond; municipal bond insurance; junk bond; investment-grade bond

Real risk-free rate of interest, ; nominal risk-free rate of interest,

Interest rate risk; maturity risk premium (MRP); reinvestment rate risk

Term structure of interest rates; yield curve

“Normal” yield curve; inverted (“abnormal”) yield curve

(5-2)
“Short-term interest rates are more volatile than long-term interest rates, so short-term bond prices are more sensitive to interest rate changes than are long-term bond prices.” Is this statement true or false? Explain.

(5-3)
The rate of return on a bond held to its maturity date is called the bond’s yield to maturity. If interest rates in the economy rise after a bond has been issued, what will happen to the bond’s price and to its YTM? Does the length of time to maturity affect the extent to which a given change in interest rates will affect the bond’s price? Why or why not?

(5-4)
If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

(5-5)
A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the viewpoint of both the firm and its bondholders.