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10 Cards in this Set
- Front
- Back
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Present Value
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An amount of money to be invested or received at an earlier time relative to the time frame of interest. The most common timing for a present value is the current year. |
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Period
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The amount of time from one interest generation event to the next. For example, for quarterly compounding, the period would be 3 months. Durations are sometimes quoted in total number of periods rather than number of years. |
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Rate
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A decimal value that allows money in one year to be converted into equivalent amounts in other years. Moving a present value forward in time, the rate is commonly referred to as the interest rate. Bringing a future value back in time, the rate is commonly referred to as the discount rate. |
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Period Rate
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The rate that is actually applied at the end of each period. |
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Stated Annual Rate
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An approximation of the effective annual rate (see below), the stated annual rate is the period rate times the number of periods in a year. The stated annual rate is often quoted in financial problems. Dividing it by the number of periods per year yields the period rate. |
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Effective Annual Rate
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The single annual rate applied once that is equivalent to the period rate applied each period with reinvestment over one year. The effective annual rate for a sub-annual problem is always greater than the stated annual rate due to the interest from earlier periods gaining interest on itself during later periods. |
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Future Value
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An amount of money to be invested or received at a later time relative to the time frame of interest |
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Compounding
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The generating of monetary interest on an investment from one time period to another |
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Sub-Annual Compounding
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The generating of monetary interest more frequently than once per year. Examples are semi-annual (every 6 months), quarterly (every 3 months), monthly, and continuous (see below). Sub-annual compounding allows interest generating in earlier periods within a given year to be added to the principal and thereby generate further interest at the end of subsequent periods within the year. |
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Continuous Compounding
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Continuous compounding is the extreme limit of sub-annual compounding for increasingly short periods. Special formulas are used for this case, with results that are a smooth extension of finite sub-annual compounding for short periods. |
