Term
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Definition
| the interest rate is applied to the previous years principle and interest combined. you earn interest on your interest |
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Term
| what is FV of compounded interest rates |
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Definition
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Term
| what is the future value of a lump sum aka an annual compounding |
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Definition
future value = present value * (1 + r/m)^n*m
where :
r = annual rate of interest
n = number of years
m = compoundings per year
r/m = rate per period = the periodic rate = I%
n*m = the total number of periods = N |
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Term
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Definition
a lump sum is a one time unique amount
ex- a one time deposit, investment, or gift. a down payment on a house or car |
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Term
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Definition
a series of equal payments equally spaced in time.
ex- equal monthly paychecks or deposits, monthly payments, semi annual bond coupons, quarterly preferred stock dividends |
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Term
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Definition
when payments occur at the end of each period. all annuities are assumed to be ordinary unless otherwise stated
*each payment earns compound interest |
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Term
| what is the future value of annuity formula? |
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Definition
FVA = PMT * [(1+ r/m)^(n*m)-1]/(r/m)
where:
PMT = the recurring payment amount
r = the annual rate of interest
n = number of years
m = compoundings per year |
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Term
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Definition
| when payments occur at the beginning of each period |
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Term
| what components of compounding leads to a higher future value ? |
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Definition
| compounding at a higher rate and more frequently lead to higher future values |
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Term
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Definition
discounting is the act of stripping away interest from the previous period's combined principle and interest
*discounting moves backward in time, from the future to the present |
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Term
| how can discounting lead to lower present values? |
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Definition
| by discounting at a higher rate and discounting more frequently, you will get lower present values |
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Term
| given that PV is the inverse of FV, what is the formula for present value of a lump sum? |
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Definition
present value = future value/[(1 +r/m)^n*m]
PV = future value * [1/(1 +r/m)^n*m] |
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Term
| at age 62 retirees are eligible to recieve ____% of their SS benefits |
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Definition
| at age 62 retirees are eligible to receive 70% of their SS benefits |
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Term
| at age 67 retirees are eligible to receive____% of their SS benefits |
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Definition
| at age 67 retirees are eligible to receive 100% of their SS benefits |
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Term
| at age 70 retirees are eligible to receive____% of their SS benefits |
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Definition
at age 70 retirees are eligible to receive 132% of their SS benefits.
SS Benefits are maximized if they are deferred to age 70 |
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Term
| A loan is the ____ of an annuity |
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Definition
a loan is the present value of an annuity
because a a series of monthly loan payments is a stream of equal monthly cash flows, it represents an annuity
the original loan amount is always a PVA
the PVA is the amount the bank is willing to "give" me in exchange for my stream of future payments |
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Term
| depreciation vs. amortization |
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Definition
depreciation spreads a tangible asset's cost over its useful life
ex- buildings, cars, computers
amorization spreads an intangible assets cost over its useful life
ex- loans, patents
depletion spreads costs of natural resources until they are exhausted
ex- oil, copper, coal |
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Term
| what are the five steps in creating an amortization schedule? |
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Definition
1. determine the beginning balance = amount of principle yet to be repaid
2. determine the monthly total payment = PMTpva = PVA/lots of math
3. determine the monthly interest payment = interest = beginning balance * (r/m)
4. determine the monthly principal payment = principal = PMT - Interest
5. determine the ending balance = ending balance = beginning balance + interest - PMT
ending balance = beginning balance - principal |
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Term
| what happens if you are trying to pay off a loan in a shorter amount of time? |
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Definition
if you pay off a loan in a shorter amount of time, you have to pay higher monthly payments, but lower total interest
in reality, rates for different time periods will differ because loans have different Maturity risk Premiums (MRPs) |
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Term
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Definition
a point is 1% of the original principal amount, paid on the day the loan is obtained.
two types:
1. origination fee: a commission paid to the lender to cover his/her cost of creating the loan
2. discount points: prepaid interest on the loan; allows the borrower to "buy" a lower rate |
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Term
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Definition
| fixed rate loans bear interest rates that never change; thus the monthly payments never change |
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Term
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Definition
| variable loans (eg. adjustable rate mortgages) bear interest rates that are reset, usually on an annual basis |
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Term
| whats the rule of thumb when determining if you can afford a house? |
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Definition
| home buyers can usually afford a home that costs 2x to 2.5x their annual gross income |
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Term
| how do lenders evaluate mortgage loan applications? |
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Definition
a lender verifies your income and credit rating as well as
1. loan to value ration
2. front end ratio
3. back end raitio |
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Term
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Definition
= original mortgage amount/value of home
should never exceed 80%, which means that the down payment is at least 20% |
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Term
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Definition
(principal + interest + taxes + insurance)/gross income
should not exceed 28%, so PITI doesn't exceed 28% of your gross income |
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Term
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Definition
(PITI + all other debt payments)/gross income
aka debt-to-income ratio
should not exceed 36%, so your total debt payments shouldn't exceed 36% of your gross income |
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