Term
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Definition
-$1 today is worth more than $1 in the future
-relationship between PV, FV, time and interest rates |
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Term
| Interest Rates (3 ways to be interpreted) |
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Definition
1) Required rate of return
2) Discount Rate
3) Opportunity Cost |
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Term
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Definition
| -Return required by investors or lenders to postpone their current consumption |
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Term
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Definition
| the rate used to discount future cash flows to allow for the time value of money |
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Term
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Definition
| opportunity cost of receiving money today as opposed to saving it for a certain period and earning a return on it |
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Term
| components of interest rates |
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Definition
real risk free rate + expected inflation + defaulted risk premium + liquidity premium + maturity risk premium
(less liquid --> higher premium) (longer maturity term --> higher premium) |
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Term
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Definition
| the risk that the borrower will fail to make a promised payment |
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Term
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Definition
compensates investors for any difficulty they might far in converting their holdings readily into cash at close to the most recent market price
ex) securities that trade infrequently require a higher liquidity premium |
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Term
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Definition
| compensates investors for the higher sensitivity of the market values of longer term debt instruments to changes in interest rates |
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Term
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Definition
| reflect the expected loss in purchasing power over the term of a loan |
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Term
| equation for future value (w compounding) |
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Definition
FV=PV(1+r)^n
r= interest rate per compounding period
n= number of compounding periods |
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Term
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Definition
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Term
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Definition
EAR= (1+periodic interest rate)^N - 1
N is number of compounding periods
**remember to convert periodic interest rate into a decimal
EAR w continuous compounding
EAR= e^r -1
where r is the STATED ANNUAL interest rate
when compounding, you earn interest on not only the principal value but also the already earned interest. so EAR gives you the effective interest rate for the year
semiannual compounding--> how much $1 will give you at the end of the year given that it is compounded semi-annually. The stated annual rate may be 12% but the actual amount earned on the $1 is more than .12 bc you earn interest on the $0.06 that was earned after 6 months and compounded |
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Term
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Definition
FV(after n years)=PV * e^(rt)
***remember to convert interest rate into decimal
-no concept of number of periods
-interest is compounding continuously |
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Term
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Definition
-represents a series of payments or receipts occurring over a specified number of equidistant periods
ex) student loan pmts, car loan pmts, insurance premiums, mortgage pmts, retirement savings |
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Term
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Definition
| annuity whose pmts are made at the END of each period |
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Term
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Definition
an annuity whose payments are made at the beginning of each period
start of period two is end of period 1!
i.e. an annuity whose pmt is to be made immediately
ex) lease pmts (made at beg of month) |
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Term
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Definition
PV=A/r
A= annuity payments
**PV at time zero would be the PV where the first payment you are receiving is after 1 period. if you are getting a payment of $10 at time 0 then add to the solution!
an annuity in which the periodic payments begin on a fixed date and continue indefinitely |
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