C5

Question 1

The effective annual rate

Answer 1

= effective annual yield
= annual percentage yield
Indicates the total amount of interest that will be earned at the end of the year

Question 2

Equivalent n-period discount rate

Answer 2

(1+r)^n -1

Question 3

Annual percentage rate

Answer 3

The amount of simple interest earned in one year

Question 4

Simple interest

Answer 4

the amount of interest earned without the effect of compounding

Question 5

Interest rate per compounding period

Answer 5

APR/k periods/year

Question 6

Converting APR to AER

Answer 6

1+AER = (1+APR/k)^k

Question 7

Amortizing loans

Answer 7

Each month you pay interest on the loan plus some part of the loan balance

Question 8

Computing loan payments

Answer 8

C= P/ 1/r (1- 1/(1+r)^n

Question 9

Outstanding loan balance

Answer 9

Calculating PV of remaining loan payments

Question 10

Nominal interest rate

Answer 10

The rates quoted by financial institutions and used for discounting or compounding cash flows

Question 11

Real interest rate

Answer 11

the rate of growth of your purchasing power, after adjusted for inflation

Question 12

Growth in purchasing power

Answer 12

growth of money/growth of prices = 1+r/1=i

Question 13

Monetary policy

Answer 13

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

Question 14

Price rigidity

Answer 14

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

Question 15

Expansionary monetary policy

Answer 15

a monetary authority lowers (increases) the short term rate to stimulate (slow down) economic activities in order to stabilize the inflation

Question 16

Inflation targeting

Answer 16

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

Question 17

Dynamic Fisher equation

Answer 17

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

Question 18

2008 Financial crisis

Answer 18

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

Question 19

zero lower bound

Answer 19

a macroeconomic problem that occurs when ST nominal interest rates is at or near zero, limiting the central banks capacity to stimulate economic growth

Question 20

Term structure

Answer 20

The relationship between investment term (maturity) and the interest rate

Question 21

Yield curve

Answer 21

A graph of the term structure

Question 22

Normal yield curve

Answer 22

people expect the economy to be performing well in the future. They expect the bank to increase the interest rate

Question 23

Inverted yield curve

Answer 23

People think the interest rate will be lower. Central bank cuts interest rates to encourage economic growth

Question 24

Interest determination

Answer 24

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

Question 25

Interest rate expectations

Answer 25

An inverted yield curve is often interpreted as a negative forecast for economic growth

Question 26

After tax interest rate

Answer 26

r - (ti x r) = r(1+ti)

Question 27

Investors cost of capital

Answer 27

The best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted