1. Four fundamental factors affect the cost of money: (1) the return that borrow

Question

1. Four fundamental factors affect the cost of money: (1) the return that borrowers expect to earn on their investments, (2) the preference of savers to spend their income in the current period rather than delay their consumption until some future period, (3) the risks associated with the investment, and (4) expected inflation. Consider the following statements that address these factors, and indicate which you think are true.

The true statements are:

A. 1 and 4

B. 2 and 3

C. 1 and 3

D. 2 and 4

2. An investment’s capital gain or loss is an important component of its yield. Read each statement about capital gains and indicate whether it is true or false.

Statement

True

False

Simon owns 200 shares of common stock of Neptune Nanotechnology Inc. The shares were purchased six years ago for $75.00 per share. Neptune pays an annual dividend of $8.00 per share, and the shares have a current market value of $20.00 per share.

Given this information, what is Simon’s six-year yield on his Neptune shares?

A. -9.33%

B. -0.097965

C. -7.93%

D. -11.66%

Statement 1: Projects Z10 and A20 are otherwise identical investments except for one important difference: The cash flows expected from Project A20 are twice as likely to be realized as those expected from Project Z10. This means that Project Z10 is more risky than Project A20. Statement 2: For the average rational investor or saver, there is an indirect, or inverse, relationship between the amount of risk exhibited by a security and the risk premium that would be required by the investor or saver. Statement 3: On average and everything else held constant, an investment that can provide a 4% return should attract more investment capital from savers/investors than an otherwise identical investment that can generate a 12% return. Statement 4: The longer the period of deferred consumption, the larger will be the maturity premium that savers and investors expect to receive, everything else held constant.

Explanation / Answer

1. Option A-1&4 are correct

2. True

3. False

4. False

5. True

6. =(20+8*6-75)/75=-9.33%

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