Questions:
1) The time value of money is the opportunity cost of passing up the earning potential of a dollar today.
2) A rational investor would prefer to receive $1,200 today rather than $100 per month for 12 months.
3) A timeline identifies the timing and amount of a stream of cash flows, along with the interest rate it earns.
4) Timelines are used for simple time value of money problems, but cannot be used for more complex problems.
5) If you only earned interest on your initial investment, and not on previously earned interest, it would be called simple interest.
6) An investment earning simple interest is preferred over an investment earning compound interest because the simplicity adds value.
7) When using a financial calculator, cash outflows generally have to be entered as negative numbers, because a financial calculator sees money "leaving your hands."
8) $10,000 invested at 10% per year for 5 years earns interest equal to $6,105.10; therefore, $10,000 invested at 10% per year for 10 years will earn interest equal to $12,210.20 (2 times $6,105.10).
9) When solving time value of money problems on a financial calculator, you must select the "end mode" when you enter the final years cash flow.
10) When solving a problem involving an annuity due, you must select the "beg" or beginning mode on your financial calculator.
The Meaning and Measurement of Risk and Return
11) Accounting profits is the most relevant variable the financial manager uses to measure returns.
12) Cash flows is the most relevant variable to measure the returns on debt instruments, while GAAP net income is the most relevant variable to measure the returns on common stock.
13) The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment.
14) Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.
15) Another name for an asset's expected rate of return is holding-period return.
Keywords: Holding Period Return, Expected Return
16) The realized rate of return, or holding period return, is equal to the holding period dollar gain divided by the price at the beginning of the period.
17) The risk-return tradeoff that investors face on a day-to-day basis is based on realized rates of return because expected returns involve too much uncertainty.
18) Variation in the rate of return of an investment is a measure of the riskiness of that investment.
19) A rational investor will always prefer an investment with a lower standard deviation of returns, because such investments are less risky.
20) For a well-diversified investor, an investment with an expected return of 10% with a standard deviation of 3% dominates an investment with an expected return of 10% with a standard deviation of 5%.
21) Due to strict stock market controls, the most a stock's value can drop in one trading day is 5%.
The Valuation and Characteristics of Bonds
22) Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinated debenture holders are less likely to be honored in the event of liquidation.
23) An example of a Eurobond is a bond issued in Asia by a U.S. Corporation with interest and principal payments made in U.S. dollars.
24) Convertible bonds decrease in value whenever the price of the company's stock increases.
25) Junk bonds are also called high-yield bonds.
26) The expected yield on junk bonds is higher than the yield on AAA-rated bonds because of the higher default risk associated with junk bonds.
27) Bonds issued in a country different from the one in which the currency of the bond is denominated are called Eurobonds.
28) Convertible bonds are debt securities that can be converted into a firm's stock at a prespecified price.
29) A mortgage bond is secured by a lien on real property.