Chapter 2
Multiple-Choice Questions
and
Answers
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1. Which of the following cannot be used as a discount
rate?
(a)
(b)
(c)
(d)
(e)
The nominal rate of interest
The real rate of interest
The after-tax nominal rate of interest
The after-tax real rate of interest
All of the above can be used as discount rate,
depending on the situation
The answer is (e)
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2. Mr. Lazrak wants to invest $1,000 for one year. Which of
the following bank accounts offers the best deal?
(a)
(b)
(c)
(d)
(e)
7.00% interest with annual compounding
6.85% interest with semi-annual compounding
6.75% interest with quarterly compounding
6.55% interest with monthly compounding
6.45% interest with daily compounding
The answer is (a).
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Why?
(a) 1.07  1  .07
2
 .0685 
(b) 1 
  1  .0697
2 

4
 .0675 
(c )  1 
  1  .0692
4 

12
 .0655 
(d) 1 
  1  .0675
12 

 .0645 
(e) 1 

365 

365
 1  .0666
© Captus Press Inc., 2012
Because (a) provides
the highest EAR
3. Janet Jopper owes her friend some money. She is given the
following alternatives of payment. If the current rate of
interest, 6%, is used as the discount rate, which of the
following alternatives of payment is the best for her?
(a)
(b)
(c)
(d)
(e)
pay $9,750 now
$2,000 per year for 5 years, each payable at the end of
the year
$1,950 per year for 5 years, each payable at the
beginning of the year
$1,800 per year for 6 years, each payable at the end of
the year
$2,000 at the end of year 1, $5,000 at the end of year
2, $3,000 at the end of year 3, and $1,200 at the end of
year 4
The answer is (b).
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Why?
(a) PV  9,750
 1

1
  8,424.73
(b) PVA  2,000

5 
 .06 .06(1.06) 
 1

1
1.06  8,706.96
(c ) PVAD  1,950

5 
 .06 .06(1.06) 
 1

1
  8,851.18
(d) PVA  1,800

6 
 .06 .06(1.06) 
2,000 5,000
3,000
1,200
(e) PV 



 9,806.14
2
3
4
1.06 (1.06)
(1.06)
(1.06)
Because (b) is the lowest in terms of payment.
© Captus Press Inc., 2012
4. If the rate of interest (the discount rate) increases,
which of the following statements is false?
(a)
(b)
(c)
(d)
(e)
The future value of an investment will increase.
The present value of an annuity will decrease.
The present value of an annuity due will increase.
The present value of an uneven stream of cash-flow
will decrease.
All the above statements are false.
The answer is (c).
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5. If the nominal rate of interest is positive, theoretically
which of the following cannot be negative?
(a)
(b)
(c)
(d)
(e)
The before-tax real rate of interest
The after-tax real rate of interest
the rate of return on a stock
The after-tax nominal rate of interest
All of the above can theoretically be negative.
The answer is (d). Note: If the rate of inflation is
high, all real rates will be negative.
© Captus Press Inc., 2012