Chapter 5
Interest Rates
Answers to Chapter 5 Review Questions
1.
An interest rate is the price of using money today rather than in the future. For example, if you want
to spend $100 today, you are foregoing interest that could be earned on that $100 if you left it in an
interestbearing account. This interest rate is the price of spending the money now.
2.
The EAR increases when discounting is more frequent because of compound interest. For a given
APR, the EAR increases as compounding increases.
3.
The formulas for valuing cash flows require that the interest rate match the length of time between
cash flows. Thus, you must match the frequency of the interest rate with the frequency of the cash
flows.
4.
The total sum of payments on a mortgage must repay the principal and all of the interest that accrues
during the mortgage period. Due to the time value of money (and compound interest), the amount of
total interest on a 30year mortgage is more than double that of a 15year mortgage. Thus, the mortgage
payment on a 15year mortgage is not quite double that of the 30year mortgage.
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 Spring '09
 LynnPi
 Interest Rates, Interest, Interest Rate, nominal interest rates

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