You Are Considering Two Equally Risky Annuities, Each of Which

question 117

Multiple Choice

You are considering two equally risky annuities, each of which pays $25,000 per year for 10 years.Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due.Which of the following statements is CORRECT?

• A) If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.
• B) A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
• C) The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
• D) The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
• E) The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.

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Definitions:

Unrealized Holding Loss

An unrealized holding loss occurs when an investment's value decreases, but the investment has not yet been sold by the holder.

Debt Trading Security

A financial instrument representing a debt that can be bought or sold in the securities market.

Available-for-sale

A classification of securities that are not actively managed for trading or held to maturity but can be sold for cash needs or other purposes.

Unrealized Holding Gain

Refers to an increase in the value of an investment that has not been sold yet, thus the gain is not "realized."