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Exam 27: Tools of Finance

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Question 221

True/False

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An increase in the interest rate causes a decrease in the future value of $1,000 that you have in a bank account today.

A) True
B) False

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Question 222

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Which of the following is not correct?

A) A risk averse person might be willing to hold stocks.
B) Other things the same, a portfolio with the stocks of a large number of companies has less risk.
C) Other things the same, the larger a portion of savings a person invests in stocks, the greater his expected return.
D) Diversification can eliminate market risk but not firm-specific risk.

E) B) and D)
F) C) and D)

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Question 223

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Figure 27-2. The figure shows a utility function for Britney. -Refer to Figure 27-2. From the appearance of the utility function, we know that

As the number of stocks in a portfolio rises,

You could borrow $2,000 today from Bank A and repay the loan, with interest, by paying Bank A $2,125 one year from today. Or, you could borrow X dollars today from Bank B and repay the loan, with interest, by paying Bank B $2,200 two years from today. In order for the same interest rate to apply to the two loans, X =

If a stock or bond is risky

In the 1990s, Fed Chair Alan Greenspan believed that the market was

You are a financial advisor and a client tells you he is concerned about the amount of risk in his portfolio. Assuming your client hasn't already done them, what two things can you suggest to reduce your client's risk? What additional information about reducing risk should you provide?

According to the rule of 70, if the interest rate is 5 percent, how long will it take for the value of a savings account to double?

Your boss asks you to do fundamental analysis of a corporation. What value is she asking for and how would you estimate this value?

Figure 27-2. The figure shows a utility function for Britney. -Refer to Figure 27-2. Suppose the vertical distance between the points (0, A) and (0, B) is 5. If her wealth increased from $1,050 to $1,350, then

Suppose that John can buy a savings bond for $500 that matures in ten years and pays John $1,000 with certainty. He is indifferent between this bond and another $500 bond that has some risk but on which the interest rate is 5% higher. How much, to the nearest penny, does the riskier bond pay in ten years?

If the interest rate is 7.5 percent, then what is the present value of $4,000 to be received in 6 years?

Greg's Tasty Ice Cream is considering building a new ice cream factory that costs $8.3 million. The company accountants believe that, not accounting for interest costs, building the factory will increase profits by $5 million the first year, $4 million the second year and have no value thereafter. Greg's Tasty Ice Cream should build the factory if the interest rate is

Diversification can reduce firm-specific risk.

Dobson Construction has an investment project that would cost $150,000 today and yield a one-time payoff of $167,000 in three years. Among the following interest rates, which is the highest one at which Dobson would find this project profitable?

What's the difference between firm-specific risk and market risk? Will diversification eliminate one or both? Explain.

There are many concerns for risk-averse lenders. Consider the following: 1. Lenders are concerned that borrowers with the greatest risk are the ones most likely to actively pursue loans. 2. Lenders are concerned that real GDP will decline leading to reduced corporate profits. 3. Lenders are concerned that products produced by certain corporations will become obsolete.

Historically, stocks have offered higher rates of return than bonds.

If you presently have $50,000 saved and earn 15 percent interest per year, about how many years will it take for your investment to triple?