CHAPTER 5 QUESTIONS AND
ANSWERS GRADED A+
i Annuity - A level stream of cash flows for a fixed period of time
Annuity due - An annuity for which the cash flows occur at the beginning of the period
Perpetuity - An annuity in which the cash flows continue forever
Consol - A type of perpetuity
Effective annual rate (EAR) - The interest rate expressed as if it were compounded once per year
Annual percentage rate (APR) - The interest rate charged per period multiplied by the number of periods
per year
Should lending laws be changed to require lenders to report EAR's instead of APR's? Why or why not? -
Yes, they should. APR's generally don't provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
As you increase the length of time involved, what happens to the present value of annuity? What
happens to the future value? - Assuming positive cash flows and a positive interest rate, both the
present and the future value will rise.
What happens to the future value of an annuity if you increase the rate? What happens to the present
value? - Assuming positive cash flows and a positive interest rate, the present value will fall, and the
future value will rise.
In words, how would you go about valuing the subsidy on a subsidized Stafford loan? - The subsidy is the
present value (on the day the loan is made) of the interest that would have accrued up until the time it
actually begins to accrue. Annuity - A level stream of cash flows for a fixed period of time
Annuity due - An annuity for which the cash flows occur at the beginning of the period
Perpetuity - An annuity in which the cash flows continue forever
Consol - A type of perpetuity
Effective annual rate (EAR) - The interest rate expressed as if it were compounded once per year
Annual percentage rate (APR) - The interest rate charged per period multiplied by the number of periods
per year
Should lending laws be changed to require lenders to report EAR's instead of APR's? Why or why not? -
Yes, they should. APR's generally don't provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
ANSWERS GRADED A+
i Annuity - A level stream of cash flows for a fixed period of time
Annuity due - An annuity for which the cash flows occur at the beginning of the period
Perpetuity - An annuity in which the cash flows continue forever
Consol - A type of perpetuity
Effective annual rate (EAR) - The interest rate expressed as if it were compounded once per year
Annual percentage rate (APR) - The interest rate charged per period multiplied by the number of periods
per year
Should lending laws be changed to require lenders to report EAR's instead of APR's? Why or why not? -
Yes, they should. APR's generally don't provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
As you increase the length of time involved, what happens to the present value of annuity? What
happens to the future value? - Assuming positive cash flows and a positive interest rate, both the
present and the future value will rise.
What happens to the future value of an annuity if you increase the rate? What happens to the present
value? - Assuming positive cash flows and a positive interest rate, the present value will fall, and the
future value will rise.
In words, how would you go about valuing the subsidy on a subsidized Stafford loan? - The subsidy is the
present value (on the day the loan is made) of the interest that would have accrued up until the time it
actually begins to accrue. Annuity - A level stream of cash flows for a fixed period of time
Annuity due - An annuity for which the cash flows occur at the beginning of the period
Perpetuity - An annuity in which the cash flows continue forever
Consol - A type of perpetuity
Effective annual rate (EAR) - The interest rate expressed as if it were compounded once per year
Annual percentage rate (APR) - The interest rate charged per period multiplied by the number of periods
per year
Should lending laws be changed to require lenders to report EAR's instead of APR's? Why or why not? -
Yes, they should. APR's generally don't provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
