2. The time value of money pt. 1 Flashcards
What is future value?
The amount an investment is worth after one or more periods. also the compound value
What is compounding?
the process of accumulating interest in an investment over time to earn more interest
What is simple interest?
The method of calculating interest in which, during the entire term of the loan, interest is computed on the original sum borrowed
What is (1 + r)^t ?
The future value interest factor, for $1 invested at r per cent for t periods and can be abbreviated as FVIF(r,t)
What is interest on interest?
Its the interest earned from compounding. so its the interest earned from reinvesting the interest
What are the three main ideas of finance?
The time value of money
Diversification
Arbitrage
How to value any asset using time value of money?
Write down the asset’s cash flows
Calculate the PV of the asset’s cash flows
Sum the PV’s
What is diversification?
If investors want to make money with little risk they must diversify their investments
What is arbitrage?
The simultaneous purchase and sale of the same securities, commodities, or foreign exchange in different markets to profit from unequal prices
What is the discount rate (or discount factor)?
The interest rate that reduces a given FV to an equivalent present value
What is discounting?
The process by which, through the operation of interest, a future sum is converted to its equivalent present value
What is calculating the PV of a future cash flow?
this is called the discounted cash flow (DCF) valuation
What is the future value factor?
the opposite of the discount rate (factor)
What is annuity?
A series of cash flows of equal amount, equally spaced in time
What is ordinary annuity?
An annuity in which the time period from the date of valuation to the date of the first cash flow is equal to the time period between each subsequent cash flow. All cash flows occur at the end of the period
