Time Value of Money Quiz

Time value of money assumes that:

• A dollar received today is worth less than a dollar received in the future

• Risk and inflation are irrelevant in discounting

• Timing of cash flows does not affect valuation

• Investors prefer current consumption over future consumption

• All cash flows are tax-free

Which of the following statements is correct?

• The nominal rate equals the effective rate when interest is compounded more than once a year

• The effective annual rate is always lower than the nominal rate

• The EAR accounts for compounding, while the nominal rate does not

• Nominal and effective rates are identical when interest is continuous

• Nominal rates vary with the number of compounding periods

Holding all else constant, increasing the compounding frequency:

• Decreases the effective annual rate

• Has no effect on future value

• Increases the effective annual rate

• Lowers the nominal rate

• Reduces both present and future values

Which of the following cash flow patterns is best valued using uneven cash flow analysis?

• A fixed mortgage payment

• A corporate bond's annual interest

• Lottery payments that grow annually at 2%

• A stream of dividends increasing at a constant rate

• A start-up company's unpredictable yearly earnings

A financial timeline helps to:

• Track tax liabilities

• Represent cash flows graphically over time

• Adjust inflation rates in present value calculations

• Determine capital gains

• Identify investment risks

The assumption made in annuity calculations is that:

• Payments vary each period

• Payments are made randomly

• All payments are made at maturity

• Payments are equal and occur at regular intervals

• Interest rates fluctuate between periods

The discounting process involves:

• Determining how much interest will accumulate on an investment

• Calculating the maturity value of an annuity

• Reducing future cash flows to their present value equivalents

• Estimating taxes payable on investments

• Adjusting present value for inflation only

If two investments offer the same cash flows, but one pays sooner, which has the higher present value?

• The one with later payments

• The one with more frequent payments

• The one with higher interest

• The one with earlier payments

• Both have the same present value

Why is the future value of an annuity due higher than that of an ordinary annuity?

• Annuity due has lower payments

• Annuity due uses a lower interest rate

• Payments in an annuity due earn interest for one additional period

• Annuity due is discounted at a slower rate

• Compounding is not applicable to annuity due

The future value of a lump sum increases as:

• The discount rate decreases

• The number of periods decreases

• The interest rate increases

• The cash flow becomes irregular

• The investment is classified as a perpetuity