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17 Cards in this Set
- Front
- Back
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three ways to view interest rates
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1) required rates of return, 2) discount rates, 3) opportunity cost
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interest rate composition
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r = real risk-free interest rate + inflation premium + default risk premium + liquidity premium + maturity premium
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real risk-free interest rate
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single-period interest rate for a completely risk-free security (ex: t-bill)
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inflation premium
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Reflects the average inflation rate expected over the maturity of the debt.
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nominal risk-free interest rate
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the real risk-free interest rate + inflation premium
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default risk premium
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compensates investors for the possibility of default
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liquidity premium
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compensates investors for the risk of loss relative to an investments fair value if the investment needs to be converted to cash quickly
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maturity premium
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compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity is extended
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future value formula
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FVn = PV(1+(r/m))^mN
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continuous compounding
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FVn = Pve^rN
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effective annual rate
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EAR = ((1+ r/m)^m)-1
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effective annual rate with continuous compounding
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EAR = (e^r)-1
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future value annuity formula
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FVn = A{[(1+r)^n)-1]/r}
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present value formula
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PV = FVn(1+r/m)^-mN
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present value annuity formula
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PV = A{[1-(1/(1+r)^n)]/r}
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present value of a perpetuity
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PV = A/r
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growth rate
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g = ((FVn/PV)^1/N)-1
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