Learning Module: The Time Value of Money in Finance

1. Grupo Ignacia issued 10-year corporate bonds two years ago. The bonds pay an
annualized coupon of 10.7 percent on a semi-annual basis, and the current annualized
YTM is 11.6 percent. The current price of Grupo Ignacia’s bonds (per MXN100 of par
value) is closest to:
A. MXN95.47.
B. MXN97.18.
C. MXN95.39.

2. Grey Pebble Real Estate seeks a fully amortizing fixed-rate five-year mortgage loan
to finance 75 percent of the purchase price of a residential building that costs NZD5
million. The annual mortgage rate is 4.8 percent. The monthly payment for this
mortgage would be closest to:
A. NZD70,424.
B. NZD93,899.
C. NZD71,781.

3. Mylandia Corporation pays an annual dividend to its shareholders, and its most recent
payment was CAD2.40. Analysts following Mylandia expect the company’s dividend to
grow at a constant rate of 3 percent per year in perpetuity. Mylandia shareholders
require a return of 8 percent per year. The expected share price of Mylandia is
closest to:
A. CAD48.00.
B. CAD49.44.
C. CAD51.84.

4. Suppose Mylandia announces that it expects significant cash flow growth over the
next three years, and now plans to increase its recent CAD2.40 dividend by 10
percent in each of the next three years. Following the 10 percent growth period,
Mylandia is expected to grow its annual dividend by a constant 3 percent indefinitely.
Mylandia’s required return is 8 percent. Based upon these revised expectations, The
expected share price of Mylandia stock is:
A. CAD49.98.
B. CAD55.84.
C. CAD59.71.

5. Consider a Swiss Confederation zero-coupon bond with a par value of CHF100, a

remaining time to maturity of 12 years and a price of CHF89. In three years’ time,
the bond is expected to have a price of CHF95.25. If purchased today, the bond’s
expected annualized return is closest to:
A. 0.58 percent.
B. 1.64 percent.
C. 2.29 percent.
 The Time Value of Money in Finance

6. Grupo Ignacia issued 10-year corporate bonds four years ago. The bonds pay an
annualized coupon of 10.7 percent on a semi-annual basis, and the current price of the
bonds is MXN97.50 per MXN100 of par value. The YTM of the bonds is closest to:
A. 11.28 percent.
B. 11.50 percent.
C. 11.71 percent.

7. Mylandia Corporation stock trades at CAD60.00. The company pays an annual dividend
to its shareholders, and its most recent payment of CAD2.40 occurred yesterday.
Analysts following Mylandia expect the company’s dividend to grow at a constant rate
of 3 percent per year. Mylandia’s required return is:
A. 8.00 percent.
B. 7.00 percent.
C. 7.12 percent.

8. An analyst observes the benchmark Indian NIFTY 50 stock index trading at a

forward price-to-earnings ratio of 15. The index’s expected dividend pay-out ratio in
the next year is 50 percent, and the index’s required return is 7.50 percent. If the
analyst believes that the NIFTY 50 index dividends will grow at a constant rate of
4.50 percent in the future, which of the following statements is correct?
A. The analyst should view the NIFTY 50 as overpriced.
B. The analyst should view the NIFTY 50 as under-priced.
C. The analyst should view the NIFTY 50 as fairly priced.

9. If you require an 8 percent return and must invest USD500,000, which of the
investment opportunities in Exhibit 1 should you prefer?

Exhibit 1: Investment Opportunities

Cash flows (in ‘000) t=0 t=1 t=2 t=3
Opportunity 1 -500 195 195 195
Opportunity 2 -500 225 195 160.008

A. Opportunity 1
B. Opportunity 2
C. Indifferent between the two opportunities.

10. Italian one-year government debt has an interest rate of 0.73 percent; Italian two-
year government debt has an interest rate of 1.29 percent. The breakeven one-year
reinvestment rate, one year from now is closest to:
A. 1.01 percent.
B. 1.11 percent.
C. 1.85 percent.

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 The Time Value of Money in Finance

11. The current exchange rate between the euro and US dollar is USD/EUR1.025. Risk-
free interest rates for one year are 0.75 percent for the euro and 3.25 percent for
the US dollar. The one-year USD/EUR forward rate that best prevents arbitrage
opportunities is:
A. USD/EUR1.051.
B. USD/EUR1.025.
C. USD/EUR0.975.

12. A stock currently trades at USD25. In one year, it will either increase in value to
USD35 or decrease to USD15. An investor sells a call option on the stock, granting
the buyer the right, but not the obligation, to buy the stock at USD25 in one year.
At the same time, the investor buys 0.5 units of the stock. Which of the following
statements about the value of the investor’s portfolio at the end of one year is
correct?
A. The portfolio has a value of USD7.50 in both scenarios.
B. The portfolio has a value of USD25 in both scenarios.
C. The portfolio has a value of USD17.50 if the stock goes up and USD7.50 if the
stock goes down.

13. A consultant starts a project today that will last for three years. Her compensation
package includes the following:
Year End of year payment
1 $100,000
2 $150,000
3 $200,000

If she expects to invest these amounts at an annual interest rate of 3%, compounded
annually until her retirement 10 years from now, the value at the end of 10 years is
closest to:
A. $618,994.
B. $566,466.
C. $460,590.

14. An individual wants to be able to spend €80,000 per year for an anticipated 25 years
in retirement. To fund this retirement account, he will make annual deposits of
€6,608 at the end of each of his working years. He can earn 6% compounded annually
on all investments. The minimum number of deposits that are needed to reach his
retirement goal is closest to:
A. 28.
B. 40.
C. 51.

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15. A financial contract offers to pay €1,200 per month for five years with the first
payment made immediately. Assuming an annual discount rate of 6.5%, compounded
monthly, the present value of the contract is closest to:
A. €61,330.
B. €61,663.
C. €63,731.

16. A consumer purchases an automobile using a loan. The amount borrowed is €30,000,
and the terms of the loan call for the loan to be repaid over five years using equal
monthly payments with an annual nominal interest rate of 8% and monthly
compounding. The monthly payment is closest to:
A. €608.29.
B. €626.14.
C. €700.00.

17. An investment pays $1,000 annually for five years, with the first payment occurring
three years from today. If the discount rate is 6% compounded annually, the present
value of the investment today is closest to:
A. $3,537.
B. $3,749.
C. $4,212.

18. An investor has three options for receiving payments from an investment:
Option 1: a single payment of $136,000 today;
Option 2: 30 annual payments of $12,000, beginning one year from today;
Option 3: 20 annual payments of $13,000, beginning today.
If the annual discount rate is 8%, the option with the highest present value is:
A. Option 1.
B. Option 2.
C. Option 3.

19. An investment requires 10 equal annual payments, starting today, and will pay out a
lump sum of $500,000 15 years from today. If the interest rate is 4% per year
compounded annually, the required annual payment is closest to:
A. $32,913.
B. $34,230.
C. $40,044.

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20. An investor needs to make the following payments to cover college tuition fees,
starting 10 years from today:

Annual fee (payable at the beginning of each year) $50,000

Number of years of fee payments 4

If the investor’s annual discount rate is 3%, the minimum investment amount required
today to fund all four years of college tuition is closest to:

A. $138,294.
B. $142,442.
C. $146,716.

21. An annuity makes seven annual payments of $10,000 each, with the first payment
occurring five years from today. If the discount rate is 6% per year, the value of the
annuity today is closest to:
A. $41,715.
B. $44,218.
C. $55,824.

Solutions
1. C is correct. The coupon payments are 5.35 (=10.7/2), the discount rate is 5.8 percent
(=11.6%/2) per period, and the number of periods is 16 (=8×2). Using Equation, the
calculation is as follows:

2. A is correct. The present value of the mortgage is NZD3.75 million

(=0.75×5,000,000), the periodic discount rate is 0.004 (=0.048/12), and the number
of periods is 60 (=5×12). Using Equation,

3. B is correct. Mylandia’s next expected dividend is CAD2.472 (=2.40×1.03), and using

Equation,

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 The Time Value of Money in Finance

4. C is correct. Following the first step, we observe the following expected dividends
for Mylandia for the next three years:

5. C is correct. The FV of the bond is CHF95.25, the PV is CHF89, and the number of
annual periods (t) is 3. Using Equation,

6. A is correct. The YTM is calculated by solving for the RATE spreadsheet function
with the following inputs: number of periods of 12 (=6 × 2), coupon payments of 5.35
(=10.7/2), PV of −97.50, and FV of 100. The resulting solution for RATE of 5.64
percent is in semi-annual terms, so multiply by 2 to calculate annualized YTM of 11.28
percent.

7. C is correct. We may solve for required return based upon the assumption of constant
dividend growth using Equation:

8. B is correct. Using Equation, the previous input results in the following inequality:

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 The Time Value of Money in Finance

9. C is correct. Finding the present value of the above cash flows at 8 percent discount
rate shows that both investment opportunities have the same present value. Thus,
the two opportunities are economically identical, and there is no clear preference for
one over the other.

10. C is correct. The one-year forward rate reflects the breakeven one-year
reinvestment rate in one year, computed as follows:

11. A is correct. To avoid arbitrage opportunities in exchanging euros and US dollars,

investors must be able to lock in a one-year forward exchange rate of USD/EUR1.051
today. The solution methodology is shown below.

12. A is correct. Regardless of whether the stock increases or decreases in price, the
investor’s portfolio has a value of USD7.50 as follows: If stock price goes to USD35,
value = 0.5×35 – 10 = 7.50.

If stock price goes to USD15, value = 0.5×15 – 0 = 7.50.

If the stock price rises to USD35, the sold call option at USD25 has a value to the
buyer of USD10, offsetting the rise in the stock price.

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13.

14.

15. B is correct. Using a financial calculator: N = 60; the discount rate (I/Y) = (6.5%/12)
= 0.54166667; PMT = €1,200; Future value = €0; Mode = Begin; Calculate present value
(PV): PV = €61,662.62.

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16.

17. B is correct. To compute the Correct answer is to calculate the present value of a
series of equal cash flows, with the first cash flow in the third year. Using a calculator
with CF0=0, CF1=0, CF2=0, CF3=1,000, CF4=1,000, CF5=1,000, CF6=1,000, CF7=1,000;
I=6%; solve for NPV= 3,748.99 ~ 3,749.

18. C is correct because Option 3 (annuity due with 20 payments of $13,000 each) has
the highest present value of the annuities and the $136,000 lump sum.

Calculator solution for Option 2: End mode; N = 30; I/Y = 8; PMT = –12,000; compute
PV = 135,093.

Calculator solution for Option 3: Begin mode; N = 20; I/Y = 8; PMT = –13,000; compute
PV = 137,847.

19.

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20.

21.

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