Author Question: The rate of interest actually paid or earned, is the ________ interest rate A) effective B) ... (Read 176 times)

lidoalex · **on:** Jul 10, 2018

The rate of interest actually paid or earned, is the ________ interest rate

A) effective
B) nominal
C) discounted
D) continuous

Question 2

Your neighbor owns a perpetuity of 100 per year that has a discount rate of 6 per year.

He offers to sell to you all but the next 20 cash flows (the first to be received one year from today) for 500. In other words, he keeps the first 20 cash flows of his perpetuity and you get all of the rest. Is this a good price for you if the appropriate discount rate is 6?
A) No, because the entire perpetuity is worth only 1,666.67 and your neighbor is taking the best cash flows worth more than 1,200 in present value terms
B) Yes, because the present value of the remaining cash flows is 519.68 and you are buying them for only 500.
C) No, because the cash flows you receive are only worth 482.16 and that is less than the 500 your neighbor is asking for the cash flows.
D) This question cannot be answered.

josephsuarez · **Reply #1 on:** Jul 10, 2018

Answer to Question 1

A

Answer to Question 2

Answer: B
Explanation: B) Value of perpetuity = PMT/r = 100/.06 = 1,666.67.
PV of a 20-year annuity = PMT = 100 = 1,146.99.
The difference, or the value of the remaining cash flows = 1,666.67 - 1,146.99 = 519.68.