Chapter 2

Question 1

define interest amount and what is it’s symbol

Answer 1

• compensation for giving up use of money
• difference between amount loaned and amount repaid
• symbol is I (capital i)

Question 2

interest rate symbol?

Answer 2

i
ie = effective interest rate
is = sub-period interest rate

Question 3

formula for future worth?

Answer 3

F = P + I
= P + Pi
= P(1+i)

Question 4

define compound interest

Answer 4

if an amount of money is lent for more than 1 period interest is added on to the existing principle

Question 5

formula for future worth after compounding?

Answer 5

F = P(1+i)^N 
N = # of periods

Question 6

formula for accumulated interest (including compound)?

Answer 6

I = Pi
= F - P
= P(1+i) - P

Ic = P(1+i)^N - P

Question 7

define simple interest and what is it’s formula

Answer 7

• interest accumulated for a number of period without the compounding
  Is = Pi * N

Question 8

as N increase what happens to the difference in I between simple and compound

Answer 8

difference in I for compound and simple increases exponentially

Question 9

symbol for accumulated interest?

Answer 9

I
Ic - compound
Is - simple

Question 10

conventional approach for computing interest?

Answer 10

compound interest

Question 11

formula for effective interest rate?

Answer 11

ie = (1+is)^m - 1

Question 12

formula for sub period interest rate?

Answer 12

is = r/m
where …
r = nominal rate
m = # of equal compounding periods

Question 13

define effective interest rate?

Answer 13

• the percentage of total amount of money paid/earned after compounding

Question 14

formula for effective interest rate under continuous compounding?

Answer 14

ie = e^r - 1

Question 15

define continuous compounding

Answer 15

• interest that is compounded more than daily

- not used often

Question 16

most common type of compounding?

Answer 16

discrete

Question 17

when do cash flows occur?

Answer 17

at the ends of periods

Question 18

what does time 0 represent?

Answer 18

now/present

Question 19

name the 3 types of equivalence used to compare costs/benefits

Answer 19

1. mathematical
2. decisional
3. market

Question 20

define discounting and compounding

Answer 20

• discounting is to fine present value of money (by discount rates)
• compounding is to find future value of money
  (by compound interest rates)

Question 21

define mathematical equivalence

Answer 21

• mathematical relationship
• decision makers exchanges P now for F future using rate i
  F = P(1+i)^N

Question 22

define decisional equivalence

Answer 22

• decision maker is indifferent between P now or F future

- infer the implied interest rate

Question 23

define market equivalence

Answer 23

• decision makers exchange different cash flows at 0 cost

Question 24

F to P is called…

Answer 24

borrowing money

Question 25

P to F is called…

Answer 25

investing/lending money

Question 26

principal amount is…

Answer 26

present worth of money