Reading...
Play button
Play button
Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
38 Cards in this Set
- Front
- Back
|
Since money has time value, the value of an asset is...
|
not just the sum of individual cashflows.
|
|
|
In order for an assets cashflows to be added together...
|
they must be transformed to one point in time via compounding or discounting.
|
|
|
A reduction is....
|
Discounting
The transformation of value over time so it can be meaningfully added together. (time is a cashflow) |
|
|
A increase is....
|
Compounding
The transformation of value over time so it can be meaningfully added together. (time is a cashflow) |
|
|
An investment with different cashflows over multiple periods... how would you figure out the value?
|
Break the cashflow down into periods, figure out the interest for that amount depending on how long it's been invested.
p0 = 800(r)7 = that cash flow after 7 years p1 = 300(r)6 = that cash flow after 6 years etc |
|
|
Unless told explicitly otherwise, cashflows will occur at the...
|
end of a period.
|
|
|
A payment which is:
- Finite - Equal amounts - Regular intervals Is called... |
Annuity
|
|
|
A payment which is:
- Infinite - Equal payments - Regular intervals Is called... |
Perpetuity
|
|
|
What are the two types of annuity?
|
Ordinary Annuity - Occurs at the end of the period
Annuity Due - Occurs at the beginning of the period Better to have annuity due, as receiving the money sooner allows further reinvestment opportunities. Time value of money etc. |
|
|
When are annuities and perpetuities applicable?
|
1) When the values of cash flow are the same in all periods
2) When the discount rates are the same in all periods |
|
|
If provided, you can also calculate the PV of annuity by using a...
|
Present value annuity table
Take the multiplier and times it by the annuity payment amount. |
|
|
When rearranging equations...
|
Use the reverse of BODMAS. Do the most complex to the other side of the equation first.
|
|
|
In order to find the number of payments...
|
Calculate the PV formula up until the value and percentage is left. Then / both values by there In() / In().
|
|
|
If calculating annuity due, use...
|
Ordinary annuity x (1+r)
Do this before multiplying out the payment figure (and then dividing by r if calculating PV). |
|
|
What are the 2 types of interest rates?
|
APRs (annual percentage rates) or quoted rates
EAR (effective annual rate) |
|
|
What is an APR interest rate?
|
The interest charged per period, times the number of periods per year.
|
|
|
What does US and UK legislation say about quoting interest rates?
|
APR rates must be disclosed on all consumer loans.
Therefore, this is normally the quoted rate in the news etc. |
|
|
If a monthly interest rate is 0.5%, what is the APR?
|
0.5% * 12 = 6% APR
|
|
|
What is the monthly rate if the APR is 12% with monthly compounding?
|
12% / 12 = 1%
Compounding in this sense just means as it increases. |
|
|
What is the EAR?
|
Effective annual rate
The actual rate paid after accounting for compounding that occurs during the year (the interest rate expressed as if it were compounded once per year). |
|
|
When compounding occurs all the time, it is called....
|
Continuous compounding.
|
|
|
If the period is anually, the interest rate should be ________, whereas if the period is monthly, the interest rate should be _________.
|
anually.
monthly. |
|
|
What is the difference between APR and EAR?
|
APR = Simple interest
EAR = Compounded interest It is known as the mathematically correct APR. |
|
|
APR and EAR are the same only when
|
Compounding occurs once a year.
|
|
|
Why do banks show an APR?
|
So you see a lower number.
However when illustrating savings, might show an EAR so you see a higher figure. |
|
|
Why is EAR useful?
|
It can be used to compare 2 investments with different compounding periods.
|
|
|
It is important to only work with ___________ in interest.
|
Effective rates.
|
|
|
To find the payment of an annuity...
|
Use the PV formula and then rearrange at the end to find C.
|
|
|
What are 3 basic types of loan?
|
- Pure discount loans
- Interest-only loans - Amortised loans |
|
|
What is a pure discount loan?
|
- Borrow recieved money today and repays a single lump sum at the end of the loan.
No interest payments. Example: Zero coupon bonds |
|
|
What is an interest only loan?
|
Require payment of interest EACH PERIOD, and then repayment of the principal at a later date.
Principal is paid all at once. |
|
|
What is an amortised loan?
|
Principal is repaid over time
Periodic payments = interest + repayment of a portion of the principal. As such principal gets smaller and interest is only calculated on the remainder of the principal. Example: housing loans (mortgages). |
|
|
What is an amortisation schedule?
|
A table that describes the periodic payments as well as interest and principal balance after each payment.
|
|
|
What are the 2 types of amortised loans?
|
- Fixed Principal
Principal reduction is constant each year Periodic payment reduces each year as interest paid on remaining balance reduces. - Fixed Payments (more common) Periodic payment (total ammount repayed) is constant each year. Principal paid increases over time, Interest decreases over time. |
|
|
Why is a fixed periodic payment perhaps safer than a fixed principal payment.
|
With fixed periodic payment you always know how much you need to pay, it remains constant.
Also, generally more cash at the beginning. |
|
|
When calculating the closing balance of amortisation schedules, CB =
|
CB = OB - Principal Paid
(INTEREST IS NOT INCLUDED IN THIS CALCULATION) |
|
|
When the values of a cash flow, and the interest rate, is the same in all periods... what is applicable?
|
An annuity if finite, a perpetuity if infinite.
|
|
|
How do you figure out EAR?
|
1) Take APR and form a decimal
2) Divide decimal by periods in year (monthly = 12) 3) Use FV = £1 ( .... to figure out effective interest growth |
