(6) Quantitative Methods: TMV (Kyle Created) Flashcards
Interest Rates (r) can be thought of in 3 ways
- Required rate of return
- Discount rate
- Opportunity cost
Required rate of return
minimum rate of return an investor must receive in order to accept the investment (AKA interest rate)
Discount Rate
the rate at which some future value is discounted to arrive at a value today (AKA interest rate)
Opportunity cost
value that investors forgo by choosing a particular course of action (aka interest rate)
Suppose i lend you $1000 for one year, i will want the following:
- real risk-free rate
- inflation premium
- default risk premium
- liquidity premium
- maturity premium
Real risk-free rate
Single period interest rate for a completely risk-free security if no inflation were expected.
Nominal risk-free interest rate =
Real risk free interest rate + inflation premium
These are the rates quoted in the market (i.e. bank)
FV of a single cash flow =
PV (1+r) ^n
PV of a single cash flow =
FV / (1+r) ^n
Continuous compounding formula
e^r*n
Effective annual rate (EAR) =
(1 + periodic interest rate)^m - 1
m = the number of compounding periods in one year
periodic interest rate = stated rate / m
Annuity
a finite set of level sequential cash flows
Ordinary annuity
payment is made at the end of the first year
Annuity due
payment is made at the beginning of the first year
How do you calculated annuity due using ordinary annuity?
Multiply ordinary annuity answer by (1+ interest rate)
