1. The principal of the time value of money is probably the single most importan

Question

1. The principal of the time value of money is probably the single most important concept in financial management. One of the most frequently encountered applications involves the calculation of a future value.

(Compound interest OR simple interest) occurs when interest is not earned on prior periods’ interest.

2. Which of the following is not one of these variables?

A. The present value (PV) of the amount invested

B. The interest rate (r) that could be earned by invested funds

C. The inflation rate indicating the change in average prices

D. The duration of the investment (n)

3. Line A corresponds to (17%, %0, or 8%), while Line B is consistent with (17%, %0, or 8%). Line C corresponds to (17%, %0, or 8%).

4. Investments and loans base their interest calculations on one of two possible methods: the (simple or complex) interest and the (uncomplicated or compound) interest methods. Both methods apply three variables—the amount of principal, the interest rate, and the investment or deposit period—to the amount deposited or invested in order to compute the amount of interest. However, the two methods differ in their relationship between the variables.

5. Assume that the variables r, n, and PV represent the interest rate, investment or deposit period, and present value of the amount deposited or invested, respectively.

Which equation best represents the calculation of a future value (FV) using simple interest?

A. FV=PV (PV×r×n)

B. FV=PV + (PV×r×n)

C. FV=PV × (PV×r×n)

D. FV=PV / 1×r×n

Which equation best represents the calculation of a future value (FV) using compound interest?

A. FV=PV + (PV×r×n)

B. FV=(1+r^n) / $30,000.00

C. FV=PV / (1 + r^n)

D. FV=PV × (1 + r)^n

6. Identify whether the following statements about the simple and compound interest methods are true or false.

True

False

7. Paolo is willing to invest $30,000.00 for nine years, and is an economically rational investor. He has identified three investment alternatives (A, B, and C) that vary in their method of calculating interest and in the annual interest rate offered. Since he can only make one investment during the nine-year investment period, complete the following table and indicate whether Paolo should invest in each of the investments.

Note: When calculating each investment’s future value, assume that all interest is compounded annually. The final value should be rounded to the nearest whole dollar.

True

False

The process of earning simple interest does not allow a depositor or investor to earn interest on any previously earned interest. All other factors being equal, when interest is paid annually, both the simple interest and the compound interest methods will generate different amounts of earned interest by the end of the first year. The process of earning compound interest allows a depositor or investor to earn interest on any interest earned in prior periods. All other things being equal, the numerical difference between a present and a future value corresponds to the amount of interest earned during the deposit or investment period. Each line on the following graph corresponds to an interest rate: 096, 896, or 11%. Identify the interest rate that corresponds with each line. 20000 15000 10000 5000 0 1 23 45 6 7 8 910 TIME (periods)

Explanation / Answer

As per rules I will answer the first 4 sub parts of the question

1:Simple interest

(Under simple interest the interest is not earned on previous periods interest. It is paid only on principal amount.)

2: C the inflation rate

(For computing future value, the formula is PV*(1+r)^n, so we require PV, rate and period)

3:

Line A = 17% (This shows the highest difference which is due to high rate of discounting)

Line B = 8% (This is the next highest difference which is due to mid level discounting)

Line C= 0% (Since at 0% discounting there will be no difference between present and future values)

4: Simple; compound

Under simple interest method, the amount is calculated based on principal plus interest whereas under compound interest method, the amount is calculated as principal plus cumulated interest on interest also.

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