# Chapter 4

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question
Marcos is investing \$5 today at 7 percent interest so he can have \$35 later. This \$35 is referred to as the:
future value.
Explanation: The \$35 is referred to as the future value of the investment. The future value is the amount that the investment will be worth at a future date, taking into account the interest that has accrued. In this case, the future value is \$35 because that is the amount that Marcos will have after the investment has grown for a period of time at 7 percent interest.
question
Tomas earned \$89 in interest on his savings account last year and has decided to leave the \$86 in his account this coming year so it will earn interest. This process of earning interest on prior interest earnings is called:
compounding.
Explanation: This process of earning interest on prior interest earnings is called compounding.
question
Jamie earned \$14 in interest on her savings account last year. She has decided to leave the \$14 in her account so that she can earn interest on the \$14 this year. The interest earned on last year's interest earnings is called:
interest on interest.
Explanation: The interest earned on last year's interest earnings is called compound interest." Compound interest is when you earn interest on your original investment, plus any interest that has already been earned. This can help your money grow faster than if you were just earning interest on your original investment."
question
Lester had \$6,270 in his savings account at the beginning of this year. This amount includes both the \$6,000 he originally invested at the beginning of last year plus the \$270 he earned in interest last year. This year, Lester earned a total of \$282.15 in interest even though the interest rate on the account remained constant. This \$282.15 is best described as:
compound interest.
Explanation: The \$282.15 that Lester earned in interest this year is best described as compound interest. Compound interest is interest that is earned not only on the original investment, but also on the interest that has been accumulated over time. In this case, the interest that Lester earned this year was earned on both the original \$6,000 investment as well as on the \$270 in interest that was accumulated over the course of last year.
question
By definition, a bank that pays simple interest on a savings account will pay interest:
only on the principal amount originally invested.
Explanation: A bank that pays simple interest on a savings account will pay interest on the principal, which is the amount of money deposited into the account, at a set rate for the duration of the account. The interest is paid out at the end of the account term.
question
Katlyn needs to invest \$5,318 today in order for her savings account to be worth \$8,000 six years from now. Which one of the following terms refers to the \$5,318?
Present value
Explanation: The \$5,318 is the present value of the account. The present value is the amount of money that must be invested today in order to have a certain amount of money in the future. In this case, Katlyn needs to invest \$5,318 today in order to have \$8,000 six years from now.
question
Lucas expects to receive a sales bonus of \$7,500 one year from now. The process of determining how much that bonus is worth today is called:
discounting.
Explanation: The process of determining how much that bonus is worth today is called present value. The present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. In order to calculate the present value, you need to know the future value of the bonus, the interest rate, and the number of years until the bonus is received.
question
The interest rate used to compute the present value of a future cash flow is called the:
discount rate.
Explanation: The interest rate used to compute the present value of a future cash flow is called the discount rate. This rate is used to discount the future cash flow back to its present value.
question
Computing the present value of a future cash flow to determine what that cash flow is worth today is called:
discounted cash flow valuation
Explanation: The present value of a future cash flow is the current value of that cash flow. This can be determined by discounting the cash flow at the appropriate interest rate.
question
Kendall is investing \$3,333 today at 3 percent annual interest for three years. Which one of the following will increase the future value of that amount?
Increasing the interest rate
Explanation: A. Investing an additional \$1,000 todayB. Investing an additional \$1,000 one year from todayC. Investing an additional \$1,000 two years from todayThe answer is B. Investing an additional \$1,000 one year from today. This is because the interest is compounded annually, so the additional \$1,000 will earn interest for the full three years.
question
Rob wants to invest \$15,000 for 7 years. Which one of the following rates will provide him with the largest future value?
4 percent interest, compounded annually
Explanation:A. Investing an additional \$1,000 todayB. Investing an additional \$1,000 one year from todayC. Investing an additional \$1,000 two years from todayThe answer is B. Investing an additional \$1,000 one year from today. This is because the interest is compounded annually, so the additional \$1,000 will earn interest for the full three years.
question
Jenny needs to borrow \$5,500 for four years. The loan will be repaid in one lump sum at the end of the loan term. Which one of the following interest rates is best for Jenny?
6.5 percent simple interest
Explanation: The interest rate that is best for Jenny is the one that will result in the lowest total amount of interest paid over the life of the loan. In this case, the interest rate that is best for Jenny is the one that will result in the lowest monthly payment.
question
The future value of a lump sum investment will increase if you:
increase the time period.
Explanation: The future value of a lump sum investment will increase if you:1. Invest for a longer period of time. The longer you invest, the more time your money has to grow.2. Invest in a higher-yielding investment. A higher yield means your investment will grow at a faster rate.3. Reinvest your earnings. reinvesting your earnings allows you to compound your returns, so you earn money on your original investment plus any interest or dividends that it earns.4. Make regular contributions. Making regular contributions to your investment will also help it to grow faster, since you're effectively giving it more money to work with.5. Avoid withdrawals. Withdrawals will reduce the amount of money you have invested, and can therefore negatively impact your future returns.
question
Which one of the following is the correct formula for the current value of \$600 invested today at 5 percent interest for 6 years?
PV = \$600 / (1 + .05)6
Explanation: The correct formula for the current value of \$600 invested today at 5 percent interest for 6 years is:Current value = \$600 * (1 + 0.05)^6Current value = \$600 * 1.3164Current value = \$798.44
question
Given an interest rate of zero percent, the future value of a lump sum invested today will always:
remain constant, regardless of the investment time period.
Explanation: Given an interest rate of zero percent, the future value of a lump sum invested today will always be equal to the present value. This is because, at a zero percent interest rate, there is no time value of money and therefore no growth in the value of the investment.
question
Jessica invested \$2,000 today in an investment that pays 6.5 percent annual interest. Which one of the following statements is correct, assuming all interest is reinvested?
She could have the same future value and invest less than \$2,000 initially if she could earn more than 6.5 percent interest
Explanation: Over the next 10 years, the value of Jessica's investment willAssuming all interest is reinvested, the value of Jessica's investment will grow to \$3292.50 over the next 10 years.
question
All else held constant, the future value of a lump sum investment will decrease if the:
interest is changed to simple interest from compound interest.
Explanation: The future value of a lump sum investment will decrease if the interest rate decreases. This is because the interest rate is used to calculate how much the investment will be worth in the future, and a lower interest rate will result in a lower future value.
question
Which one of the following will increase the present value of a lump sum future amount to be received in 15 years?