Exam 27: Tools of Finance

Nancy would like to double the money in her retirement account in five years. According to the rule of 70, what rate of interest would she need to earn to attain her objective?

The fact that we observe a trade-off between risk and return is puzzling to economists, because that observation conflicts with the notion that most people are risk averse.

Suppose you win the lottery and one of your payment options is to receive $20,000 today, $20,000 one year from now, and $20,000 two years from now. If the interest rate is 5%, what is the present value of this option?

Rita puts $10,000 into each of two different assets. The first asset pays 10 percent interest and the second pays 5 percent. According to the rule of 70, what is the approximate difference in the value of the two assets after 14 years?

Happy Trails, a bicycle rental company, is considering purchasing three additional bicycles. Each bicycle would cost them $249.66. At the end of the first year the increase to their revenues would be $140 per bicycle. At the end of the second year the increase to their revenues again would be $140 per bicycle. Thereafter, there are no increases to their revenues. At which of the following interest rates is the sum of the present values of the additional revenues closest to the price of a bicycle?

Draw graphs showing the following three relationships. 1. The relation between utility and wealth for a risk averse consumer. 2. The relation between standard deviation and the number of stocks in a portfolio. 3. The relation between return and risk.

Diversification reduces

At which interest rate is the present value of $35.00 two years from today equal to about $30.00 today?

A firm has three different investment options. Option A will give the firm $10 million at the end of one year, $10 million at the end of two years, and $10 million at the end of three years. Option B will give the firm $15 million at the end of one year, $10 million at the end of two years, and $5 million at the end of three years. Option C will give the firm $30 million at the end of one year, and nothing thereafter. Which of these options has the highest present value?

A person who is risk averse might accept a 50% chance of losing $100 today in exchange for a 50% chance of winning $125 in two years if the interest rate was

Adverse selection is illustrated by people who take greater risks after they purchase insurance.

An increase in the number of corporations in a portfolio from 110 to 120 reduces

A person who is risk averse will like gaining $1,000 more than they will dislike losing $1,000.​

Compounding refers directly to

In which of the following instances is the present value of the future payment the largest?

The rule of 70 applies to a growing savings account but not to a growing economy.

According to the rule of 70, if the interest rate is 10 percent, about how long will it take for the value of a savings account to double?

The present value of $100 to be paid in two years is less than the present value of $100 to be paid in three years.

The market for insurance is one example of reducing risk by using diversification.

You are tearing down a building and find $1 in change that someone lost when working on the building 140 years ago. If, instead of being careless with the $1 in change, this person had deposited it into a bank and earned 2 percent interest every year for 140 years, how much would be in the account today according to the rule of 70?