Concepts Review and Critical Thinking Questions

1. Present Value The basic present value equation has four parts. What are they?

2. Compounding What is compounding? What is discounting?

3. Compounding and Period As you increase the length of time involved, what happens to future values? What happens to present values?

4. Compounding and Interest Rates What happens to a future value if you increase the rate r? What happens to a present value?

5. Ethical Considerations Take a look back at Example 5.7. Is it deceptive advertising? Is it unethical to advertise a future value like this without a disclaimer?

To answer the next five questions, refer to the GMAC security we discussed to open the chapter.

6. Time Value of Money Why would GMAC be willing to accept such a small amount today ($500) in exchange for a promise to repay 20 times that amount ($10,000) in the future?

7. Call Provisions GMAC has the right to buy back the securities anytime it wishes by paying $10,000 (this is a term of this particular deal). What impact does this feature have on the desirability of this security as an investment?

8. Time Value of Money Would you be willing to pay $500 today in exchange for $10,000 in 30 years? What would be the key considerations in answering yes or no? Would your answer depend on who is making the promise to repay?

9. Investment Comparison Suppose that when GMAC offered the security for $500, the U.S. Treasury had offered an essentially identical security. Do you think it would have had a higher or lower price? Why?

10. Length of Investment The GMAC security is actively bought and sold on the New York Stock Exchange. If you looked in The Wall Street Journal today, do you think the price would exceed the $500 original price? Why? If you looked in the year 2008, do you think the price would be higher or lower than today's price? Why?

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