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Corporate Finance, 3e (Berk/DeMarzo) Chapter 5 Interest Rates

5.1 Interest Rate Quotes and Adjustments

1) Which of the following statements is FALSE?

A) Because interest rates may be quoted for different time intervals, it is often necessary to adjust the interest rate to a time period that matches that of our cash flows.

B) The effective annual rate indicates the amount of interest that will be earned at the end of one year.

C) The annual percentage rate indicates the amount of simple interest earned in one year. D) The annual percentage rate indicates the amount of interest including the effect of compounding. Answer: D Diff: 1

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Conceptual

2) Which of the following equations is INCORRECT? A) - 1= APR

B) Equivalent n-Period Discount Rate = (1 + r)n - 1 C) 1 + EAR =

D) Interest Rate per Compounding Period =

Answer: A Diff: 2

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Conceptual

3) The effective annual rate (EAR) for a loan with a stated APR of 8% compounded monthly is closest to: A) 7.72% B) 8.00% C) 8.30% D) 8.66% Answer: C

Explanation: C) EAR = (1 + APR/k)k - 1 = (1 + .08/12)12 - 1 = .083 or 8.3% Diff: 1

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Analytical

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4) The effective annual rate (EAR) for a loan with a stated APR of 10% compounded quarterly is closest to: A) 9.65% B) 10.00% C) 10.38% D) 12.50% Answer: C

Explanation: C) EAR = (1 + APR/k)k - 1 = (1 + .10/4)4 - 1 = .1038 or 10.38% Diff: 1

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Analytical

5) The effective annual rate (EAR) for a savings account with a stated APR of 4% compounded daily (use 365 day year) is closest to: A) 3.92% B) 4.00% C) 4.08% D) 14.60% Answer: C

Explanation: C) EAR = (1 + APR/k)k - 1 = (1 + .04/365)365 - 1 = .04088 or 4 .08% Diff: 1

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Analytical

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Use the table for the question(s) below.

Consider the following investment alternatives: Investment Rate Compounding A 6.25% Annual B 6.10% Daily C 6.125 Quarterly D 6.120 Monthly 6) Which alternative offers you the highest effective rate of return? A) Investment A B) Investment B C) Investment C D) Investment D Answer: D

Explanation: D) EAR (A) = (1 + APR/k)k - 1 = (1 + .0625/1)1 - 1 = .0625 or 6.250% EAR (B) = (1 + APR/k)k - 1 = (1 + .0610/365)365 - 1 = .06289 or 6.289% EAR (C) = (1 + APR/k)k - 1 = (1 + .06125/4)4 - 1 = .06267 or 6.267% EAR (D) = (1 + APR/k)k - 1 = (1 + .0612/12)12 - 1 = .06295 or 6.300% Diff: 2

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Analytical

7) Which alternative offers you the lowest effective rate of return? A) Investment A B) Investment B C) Investment C D) Investment D Answer: A

Explanation: A) EAR (A) = (1 + APR/k)k - 1 = (1 + .0625/1)1 - 1 = .0625 or 6.250% EAR (B) = (1 + APR/k)k - 1 = (1 + .0610/365)365 - 1 = .06289 or 6.289% EAR (C) = (1 + APR/k)k - 1 = (1 + .06125/4)4 - 1 = .06267 or 6.267% EAR (D) = (1 + APR/k)k - 1 = (1 + .0612/12)12 - 1 = .06295 or 6.300% Diff: 2

Section: 5.1 Interest Rate Quotes and Adjustments Skill: Analytical

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Copyright ? 2014 Pearson Education, Inc.