1.

B
2. True
3. B
4. Annuity
5. True
6. D
7. True
8. A
9. True
10.D
11.C
12.C
13.True
14.True
15.C
16.D
17.D
18.True
19.False
20.D
21.B
22.B
23.C
24.F
25.True
26.True
27.Optimal
28.True
29.A
30.C

1. The principle that potential return rises with an increase in risk. Low levels
of uncertainty (low-risk) are associated with low potential returns, whereas
high levels of uncertainty (high-risk) are associated with high potential
returns. According to the risk-return tradeoff, invested money can render
higher profits only if it is subject to the possibility of being lost. Because of
the risk-return tradeoff, you must be aware of your personal risk tolerance
when choosing investments for your portfolio. Taking on some risk is the
price of achieving returns; therefore, if you want to make money, you can't
cut out all risk.
Statistical measures of risk are:
Correlation Coefficient: A statistic gauging the relationship between two
variables. The range is from -1 to +1. -1 indicates inverse correlation, 0
indicates no relationship between the variables and +1 indicates complete
correlation between them.
Coefficient of Determination (R2): A statistical measure which one arrives
at by squaring the correlation coefficient. This statistic describes the
degree of variability of a dependent variable that is explained by changes
in the independent variable.
Coefficient of Variation: The measure of dispersion of a probability
distribution. The standard deviation divided by the mean. In finance, the
ratio measures the amount of risk per unit of mean return and is helpful in

gauging relative risk in terms of degree of data dispersion. The formula is

written as follows: Cv=/
2. Preferred stock is considered to be a hybrid security, having some of the
characteristics of common stock but also resembling fixed income
offerings in many respects. Unlike common stocks, preferred stocks tend
to stay relatively stable in price after their issuance.
Some of the major advantages that they offer include higher rates of
interest, preferential dividend payout, price stability, greater liquidity and
smaller upfront investment costs. Some of the disadvantages are lack of
voting rights, callability, nonpayement of dividends and lack of capital
gains.
3.
a. Commercial Banks are the largest among all financial intermediaries
and are also the most diversified due to the large range of assets
and liabilities they hold. Their liabilities are in the form of checking
and savings deposits, and various types of time deposits. The assets
that commercial banks hold are securities of various forms and
denominations such as mortgage loans, consumer loans, business
loans and loans to state and local governments. Commercial banks
are among the most regulated forms of business due to their vital
role in the well-being of the economy.
b. Thrift institutions offer checking and savings accounts and other
various types of time-deposits and use these funds to purchase
long-term mortgages. Savings and loans are the largest residential
mortgage lenders. Thrift Institutions specialize in maturity inter
Mediation since they take liquid deposits and lend the out in the
form of long-term Collateralized loans.
c. Credit Unions are small non-profit depository institutions that are
owned by their members who are also their customers. Members of
credit unions all have a common Bond such as military service,
occupation etc. Credit unions primary liabilities are checking
deposits (share drafts) and savings accounts (share accounts) and
credit unions usually make their Investment s in the form of shortterm instalment consumer loans.
4. The four most fundamental factors affecting the cost of money are
production opportunities, time preferences for consumption, risk, and
inflation. Production opportunities are the investment opportunities in
productive (cash-generating) assets. Time preferences for consumption
are the preferences of consumers for current consumption as opposed to
saving for future consumption. Risk, in a financial market context, is the
chance that an investment will provide a low or negative return. Inflation is
the amount by which prices increase over time. The interest rate paid to
savers depends on the rate of return producers expect to earn on invested
capital, on savers time preferences for current versus future consumption,
on the riskiness of the loan, and on the expected future rate of inflation.
Producers expected returns on their business investments set an upper
limit to how much they can pay for savings, while consumers time
preferences for consumption establish how much consumption they are
willing to defer, hence how much they will save at different interest rates.
Higher risk and higher inflation also lead to higher interest rates.

5. Capital budgeting is the process of determining whether or not an

investment is worthwhile. Often companies will have several opportunities
and must measure each one's potential in order to make a comparison
and choose just one or a few. For example, a company might be trying to
determine whether to buy new equipment to expand production capacity
on an existing product, or to invest in research and development for a new
product. The three main methods of taking this measurement are Net
Present Value (NPV), Internal Rate of Return (IRR) and Payback Period.
NPV: Net Present Value, or NPV, combines two concepts of value. First, it
determines how much cash will flow in as a result of the investment, and
compares that against the cash that will flow out in order to make the
investment. Since these flows take place over time, and often the
investment will pay off much later, we also take into account the present
and future value of money. Because of inflation, money earned in the
future is worth less in today's dollars than the same amount would be
today. Therefore, NPV calculates all of those inflows and outflows over
time, takes inflation and foreign exchange rates into account, and
expresses the final benefit to the company in terms of today's dollars.
IRR: Internal Rate of Return is a percentage very similar to an interest rate,
and is used to compare a capital investment against other kinds of
investment. Divide the expected profit by the expected expenditure, and
you'll arrive at a percentage of returns. Then look at the company's other
projects and determine the minimum acceptable percentage of return; this
is called the hurdle rate. If the IRR is higher than the hurdle rate, the
project is worth pursuing. The IRR is easy to understand, and is thus the
most commonly used technique, though the NPV is more accurate.
Payback period: Very simply, the payback period tells you how long it will
take to recover your investment in a project. If it will take one year to
make back the investment from revenues from a new product, the
payback period is 1. The payback period method is antiquated and falling
into disuse, because it has some significant drawbacks. It doesn't take into
account the time value of money, and it tends to favor very cyclical
products that make the bulk of their money up front, rather than those
that build momentum and can produce cash inflows over a long period.

1. FV = PV(1+r)n = 27500(1+8%)8 = 50900.58

2. FV = 2345(1+6%)10 + 2345(1+6%)9 + + 2345(1+6%)1 = 32763.51
3. PV = 15000/(1+10%)0 + 15000/(1+10%)1 + + 15000/(1+10%)4 =
62547.98
4. Let the payment be x
PV = x/(1+5%)1 + x/(1+5%)2 + + x/(1+5%)5 = 15000
So, x = 3464.62