Chapter 2 Flashcards
define interest amount and what is it’s symbol
- compensation for giving up use of money
- difference between amount loaned and amount repaid
- symbol is I (capital i)
interest rate symbol?
i
ie = effective interest rate
is = sub-period interest rate
formula for future worth?
F = P + I
= P + Pi
= P(1+i)
define compound interest
if an amount of money is lent for more than 1 period interest is added on to the existing principle
formula for future worth after compounding?
F = P(1+i)^N N = # of periods
formula for accumulated interest (including compound)?
I = Pi
= F - P
= P(1+i) - P
Ic = P(1+i)^N - P
define simple interest and what is it’s formula
- interest accumulated for a number of period without the compounding
Is = Pi * N
as N increase what happens to the difference in I between simple and compound
difference in I for compound and simple increases exponentially
symbol for accumulated interest?
I
Ic - compound
Is - simple
conventional approach for computing interest?
compound interest
formula for effective interest rate?
ie = (1+is)^m - 1
formula for sub period interest rate?
is = r/m
where …
r = nominal rate
m = # of equal compounding periods
define effective interest rate?
- the percentage of total amount of money paid/earned after compounding
formula for effective interest rate under continuous compounding?
ie = e^r - 1
define continuous compounding
- interest that is compounded more than daily
- not used often
most common type of compounding?
discrete
when do cash flows occur?
at the ends of periods
what does time 0 represent?
now/present
name the 3 types of equivalence used to compare costs/benefits
- mathematical
- decisional
- market
define discounting and compounding
- discounting is to fine present value of money (by discount rates)
- compounding is to find future value of money
(by compound interest rates)
define mathematical equivalence
- mathematical relationship
- decision makers exchanges P now for F future using rate i
F = P(1+i)^N
define decisional equivalence
- decision maker is indifferent between P now or F future
- infer the implied interest rate
define market equivalence
- decision makers exchange different cash flows at 0 cost
F to P is called…
borrowing money
