Question

A. TRUE / FALSE QUESTIONS

Enter “True” or “False” on the blank preceding each question.

______ 1. A “time line” can be drawn to illustrate the cash flows associated with a given

investment.

______ 2. Calculating the present value of an expected cash flow is also known as

“compounding.”

______ 3. An “annuity due” will always be worth less than an otherwise comparable

“ordinary annuity,” because interest will compound for an additional time period.

______ 4. With a “perpetuity,” the periodic cash flow stream continues without end.

______ 5. Compounding more frequently than once per year results in a lower effective

interest rate, because you are earning interest on interest more frequently.

______ 6. U.S. Treasury bills (T-bills) are considered to be a very safe investment in

terms of being risk-free.

______ 7. A downward-sloping yield curve reflects expectations of higher future inflation

and higher future interest rates.

______ 8. The “bond indenture” is a legal document that specifies the rights of the

bondholders and the duties of the issuing corporation.

______ 9. In general, the shorter a bond’s maturity, the higher the interest rate or cost

to the issuing corporation.

______ 10. Rising interest rates in the economy cause the market value of outstanding bonds

to also increase.

______ 11. The holders of bonds issued by a given corporation are also the owners of the firm.

______ 12. Equity capital, such as common stock, is a permanent form of financing for a

corporation, as it never has to be repaid and it has no maturity date.

______ 13. Interest paid to bondholders is tax-deductible to the issuing corporation, which

lowers the cost of debt financing if the firm is profitable.

______ 14. The payment of dividends to common stockholders by a corporation is at the

discretion of the firm’s Board of Directors.

______ 15. Similar to common stock, the dividend payment on preferred stock typically varies

from year to year.

______ 16. Preferred stock is often referred to as a “hybrid” security, as it has characterizes of

both common stock and bonds.

Answer 1

1. TRUE: A TIMELINE CAN BE DRAWN TO ILLUSTRATE THE CASH FLOW AS BECAUSE OF A TIMELINE IT CREATES A STREAM IN WHICH EITHER MONEY WILL FLOW INWARDS OR OUTWARDS WHICH HELPS US TO IDENTIFY VERY EASILY.

2. FALSE: CALCULATING PRESENT VALUE OF EXPECTED CASH FLOW IS KNOWN AS DISCOUNTING. WHEREAS COMPUNDINGMEANS CALCULATING FUTURE VALUE. 

3. FALSE:   When interest rates go up, the value of an ordinary annuity goes down. On the other hand, when interest rates fall, the value of an ordinary annuity goes up. This is due to the concept known as the time value of money, which states that money available today is worth more than the same amount in the future because it has the potential to generate a return and grow

4. TRUE: PERPETUITY MEANS CASH FLOW FOR AN INDEFINITEE PERIOD OF TIME.

5. FALSE: COMPUNDING MEANS CALCULATING INTEREST ON INTEREST AND HENCE DUE TO THIS IT WILL INCREASE THE EFFECTIVE INTEREST RATE.

6.TRUE: YES RISK-FREE INVESTMENT ARE SAFE BECAUSE IT DOES NOT HAVE RISK FACTOR AND HENCE EARNING IS ALSO LOW.