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Unformatted text preview: Chapter 4: Introduction to Valuation: The Time Value of Money Answers to Concepts Review and Critical Thinking Questions 1. Compounding refers to the growth of a dollar amount through time via reinvestment of interest earned. It is also the process of determining the future value of an investment. Discounting is the process of determining the value today of an amount to be received in the future. 2. Future values grow (assuming a positive rate of return); present values shrink. 3. The future value rises (assuming a positive rate of return); the present value falls. 7. Oddly enough, it actually makes it more desirable since GMAC only has the right to pay the full $10,000 before it is due. This is an example of a call feature. Such features are discussed in a later chapter. 8. The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we will actually get the $10,000? Thus, our answer does depend on who is making the promise to repay. 9. The Treasury security would have a somewhat higher price because the Treasury is the strongest of all borrowers, and therefore has a lower rate of return....
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