C5 Flashcards
The effective annual rate
= effective annual yield
= annual percentage yield
Indicates the total amount of interest that will be earned at the end of the year
Equivalent n-period discount rate
(1+r)^n -1
Annual percentage rate
The amount of simple interest earned in one year
Simple interest
the amount of interest earned without the effect of compounding
Interest rate per compounding period
APR/k periods/year
Converting APR to AER
1+AER = (1+APR/k)^k
Amortizing loans
Each month you pay interest on the loan plus some part of the loan balance
Computing loan payments
C= P/ 1/r (1- 1/(1+r)^n
Outstanding loan balance
Calculating PV of remaining loan payments
Nominal interest rate
The rates quoted by financial institutions and used for discounting or compounding cash flows
Real interest rate
the rate of growth of your purchasing power, after adjusted for inflation
Growth in purchasing power
growth of money/growth of prices = 1+r/1=i
Monetary policy
the policy adopted by the monetary authority of a nation to maintain price stability. It operates to adjust the short term nominal rate and is able to affect the real interest rate when prices are sticky/rigid
Price rigidity
refers to the tendency of prices to remain constant or adjust slowly , despite changes in the cost of producing and selling the goods or services
Expansionary monetary policy
a monetary authority lowers (increases) the short term rate to stimulate (slow down) economic activities in order to stabilize the inflation
Inflation targeting
The announcement of official targets ranges for the inflation rate at one or more horizons, and by the explicit acknowledgement that low and stable inflation is the overriding goal of monetary policy
Dynamic Fisher equation
it=Et PIt+rt
it= nominal ST interest rate
Et PIt = expected inflation next period
rt= real interest rate
- If prices arent sticky: changes in It will not influence rt
- If prices are sticky: It will comove with rt
- increase It - increase rt - increase savings - decrease C - decrease AD - economical contraction
2008 Financial crisis
Consumer prices were falling, the inflation rate was negative, even with a 0% nominal interest rate, the inflation rate was negative, the real interest rate remained positive
zero lower bound
a macroeconomic problem that occurs when ST nominal interest rates is at or near zero, limiting the central banks capacity to stimulate economic growth
Term structure
The relationship between investment term (maturity) and the interest rate
Yield curve
A graph of the term structure
Normal yield curve
people expect the economy to be performing well in the future. They expect the bank to increase the interest rate
Inverted yield curve
People think the interest rate will be lower. Central bank cuts interest rates to encourage economic growth
Interest determination
The federal reserves determines very ST interest rates through its influence on federal funds rate, which is the rate at which banks can borrow cash reserves on an overnight basis
Interest rate expectations
An inverted yield curve is often interpreted as a negative forecast for economic growth
After tax interest rate
r - (ti x r) = r(1+ti)
Investors cost of capital
The best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted
