chapter 4 Flashcards
stream of cash flows
a series of cash flows lasting several periods. it is represented on a timeline.
timeline
a linear representation of the timing of the expected cash flows. date 0 represents the present and date 1 is one time unit later and represents the end of this time unit. timelines identify events in a transaction or investment that are easy to overlook.
compounding
the process of moving a value or cash flow forward in time. time value of money.
time value of money
the difference in value between money today and money in the future. it reflects the fact that by having money sooner, you can invest it and have more money later as a result.
compounding interest
the effect of earning ‘interest on interest’.
discounting
the process of moving a value or cash flow back in time; finding the equivalent value today of a future cash flow.
perpetuity
a stream of equal cash flows that occur at regular intervals and last forever.
consol bonds
promise the owner a fixed cash flow every year, forever. the first cash flow does not occur immediately. it arrives at the end of the first period.
payment in arrears
when the first cash flow does not occur immediately. it arrives at the end of the first period.
annuity
a stream of N equal cash flows paid at regular intervals. an annuity ends after some fixed number of payments.
growing perpetuity
a stream of cash flows that occur at regular intervals and grow at a constant rate forever. the first payment does not include growth.
growing annuity
a stream of N growing cash flows, paid at regular intervals.
internal rate of return (IRR)
the interest rate that sets the net present value of the cash flows equal to zero.
effective annual rate (EAR)
indicates the actual amount of interest that will be earned at the end of one year including the effect of compounding. this is also called interest on interest or compounded interest.
annual percentage rate (APR)
indicates the amount of simple interest earned in one year. that is, the amount of interest earned without the effect of compounding. because of this, the APR quote is typically less than the actual amount of interest you will earn.