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Questions: Department of Finance

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Towson University
Department of Finance
Fin331
Dr. M. Rhee
2010 Spring

NAME:

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1. If the interest is compounded quarterly with 8% APR, which of the following statements is CORRECT?

a. The periodic rate of interest is 2% and the effective rate of interest is 4%.
b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.
c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%.
d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.
e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.
Answer: d

2. What is the coefficient of variation for security a? Probability
Ra(State=?)
Rb(State=?)
Boom
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a. Households reduce their consumption and increase their savings.
b. A new technology like the Internet has just been introduced, and it increases investment opportunities.
c. There is a decrease in expected inflation.
d. The economy falls into a recession.
e. The Federal Reserve decides to try to stimulate the economy. Answer: b
If the new technology were so efficient that it takes an underdeveloped economy from a subsistence level, where savings are necessarily low and rates high, to a level where people can afford to save, this might cause interest rates to decline. However, it would take time for this to occur.

10. You are comparing saving $100 every month for a year vis-à-vis $1,200 at the beginning of the year. How much extra will you have at the end of the year by saving $ 1,200 at the beginning of the year instead of saving $100 each month at the end of each month. Use 6% interest rate.

a. $35.51
b. $38.44
c. $60.90
d. $63.90
e. $76.71
Answer: b

11. The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. IBM stock has a risk premium of 0.9%. What is the equilibrium rate of return on a 1-year Treasury bond?

a. 5.51%
b. 5.80%
c. 6.09%
d. 6.39%
e. 6.71% Answer: b
Note: you need to find the yield on 1-year Treasury bond not IBM’s stock
Real risk-free rate, r* 3.05%
Inflation this year 2.75%
1-year bond
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