True or False 1 Suppose you are given a positive discount or

True or False

1. Suppose you are given a positive discount (or interest/compound) rate. If you calculated the PV (present value) of a series of equal cash flows, it will always exceed the FV (future value) of the same series of cash flows.

2. All else equal, the PV (present value) of an annual ordinary annuity (i.e cash flows only happen at end of each year) increases as the frequency of compounding (# of periods per year) increases.

3. It is not feasible for a future value to be greater than its present value.

4. Early in the life of a loan a large percentage of the payment goes to reduce the outstanding principal.

Solution

1. FALSE

THE PRESENT VALUE HAS TO BE LOWER THAN FUTURE VALUE

IF WE DEPOSIT MONEY TODAY IN BANK, THAT IS PRESENT VALUE, THEN BANK WILL PAY MORE THAN WHAT WE DEPOSIT AT THE END, SO FUTURE VALUE HAS TO BE HIGHER THAN PRESENT VALUE

SAME PRINCIPAL APPLIES WHEN MAKE ANNUITY.

PRESENT VALUE IS KNOWN AS DISCOUNTING AND FUTURE VALUE IS KNOWN AS COMPOUNDING SO THE PRESENT VALUE WILL BE LOWER THAN FUTURE VALUE

2. FALSE

WHEN WE INCREASE FREQUENCY OF COMPOUNDING, IT WILL LEAD TO HIGHER DISCOUNTING, SO PV OF ANNUAL ORDINARY ANNUITY WILL DECREASE AND NOT INCREASE

SO GIVEN STATEMENT IS FALSE.

3. FALSE

AS MONEY HAS A TIME VALUE, FUTURE VALUE WILL BE MORE THAN PRESENT VALUE

4. FALSE

IN INITIAL PERIODS, THE INTEREST COMPONENT IS HIGHER THAN THE PRINCIPAL. BECAUSE INTEREST IS CALCULATED ON OUTSTANDING PRINCIPAL.