FF Qs & As Topic 2 Part 2 - FEEDBACK FORUM...

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FEEDBACK FORUM QUESTIONS TOPIC 2 FINANCIAL MATHS PART 2 Question 1   An interest rate of 10% p.a. compounding quarterly represents and effective interest rate of:  A. 10.18% p.a.  B. 10.25% p.a. C. 10.38% p.a.   D. 10.50% p.a.  Effective interest rate = EFF =  1 1 - + m m NIR Where: NIR = nominal (annual ) interest rate m = number of compounding periods per annum (p.a.), i.e. the number of times interest is calculated each  year EFF =  1 4 10 . 0 1 4 - +  = 1.1038 – 1 = 0.1038 = 10.38% 1
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Question      2      Tom, please don’t do this question as I feel it’s not a very good one, and please tell   the students such a question will not be on the test or exam. Find the present value of 3 annual cash flows with growth, the first cash flow of $X is to be received  immediately. The second cash flow will be greater than the first by 6% while the third cash flow will be  greater than the second by a further 7%. If the interest rates is 6% and 7% for the first and second years  respectively, then the present value of the cash flows is:  A. $X/[(1.05)(1.06)]  B. $3X  C. $X/(1.05)  D. $X  2
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Question      3       Assume an interest rate of 10%. What amount would an individual have to receive in 4 years time to make  them indifferent between that amount and a stream of 5 annual payments of $50 each, where the first  payment is received immediately? A. $232 B. $208 C. $190 D. $305 Since the first payment is receivede immediately, i.e. at T 0 , this means it is an annuity due. Step 1 : Find the present value (PV) of the five annual payments of $50 each using the PV of an annuity due  formula: + - + = - r r PMT PMT PV n ) 1 ( 1 + - + = - 10 . 0 ) 10 . 0 1 ( 1 50 $ 50 $ 4 PV + = 10 . 0 3169 . 0 50 $ 50 $ PV [ ] 169 . 3 50 $ 50 $ + = PV 45 . 158 $ 50 $ + = PV 45 . 208 $ = PV Step 2 : Use the Future value (FV) of a single sum formula to find the FV of $208 in four years time at a  compounding rate of 10% p.a.: FV = PV(1+r) n FV 4  = $208(1+0.10) 4 FV 4  = $208(1.4641) 3
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FV 4  = $305 Question      4     Five years ago Chris entered into a loan agreement to borrow $200,000, and repay the loan over 20 years 
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FF Qs & As Topic 2 Part 2 - FEEDBACK FORUM...

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