Chapter 3: Time Value of Money Flashcards
Simple vs. Compounded interest
Simple: interest due along with amount borrowed (principle) at the end of loan period. (Amount owed, F=P[1+i*n])
Compounded: interest due at the end of each period, amount based on amount owed at the beginning of period.
Effective interest rate
Rate which if compounded once per standard period yields same F as nominal compounded m times per period.
EIR=(F-P)/P=[1+(r/m)]^m-1
r=nominal int rate
m=number of compounding period per year
Nominal interest rate
Interest rate per standard period of time. AKA: nominal annual rate unless otherwise specified
Continuous compounding
Compounding occurs infinitely. EIR=e^r-1
Replace all (1+i)^n in factors with e^(r*n)
Infinite time period
(F/P)=(F/A)=inf
(P/F)=(A/F)=0
(P/A)=1/I
(A/P)=i
Time has no value (i=0)
(F/P)=1
(F/A)=n
(A/F)=1/n
Interest changes over time
(F/P, i, n): (1+i1)(1+i2)..(1+in)
End of period changes
- Increasing/decreasing by constant amount per time
- Increasing/decreasing by constant rate per time
BOND CERTIFICATE
states terms of bond
MATURITY DATE
final repayment date
N
TERM
time remaining until repayment date
COUPON RATE
nominal interest rate applied to bond’s face value
> PMT
FACE VALUE
monetary value indicated on bond and received at maturity, when bond is redeemed
- FV
COUPON PAYMENT
CPN=(CRxFV)/(# coupon payment per year)
COUPON BOND
- pay face value at maturity
- pay coupon interest payments