Chapter 4 Flashcards
What is the difference between a series of payments and an annuity? What are the two specific characteristics of a series of payments that make them an annuity?
An annuity is a series of payments of equal size at equal intervals. Uniform payments and equal time intervals such as months, quarters or years, are the two characteristics that make a series of payments an annuity. So, a series of payments can be an annuity but not all series of payments are annuities. If the series of payments is of different values or at different intervals, it is not an annuity.
What effect on the future value of an annuity does increasing the interest rate have? Does a change from 4% to 6% have the same dollar impact as a change from 6% to 8%?
The greater the interest rate the greater the future value of an annuity everything else held constant. Changing the interest rate from 4% to 6% will increase the annuity but with a smaller dollar increase when compared to the 6% to 8% change. For example: Annuity of $100 for five years at 4%: Future Value is $541.63 Annuity of $100 for five years at 6%: Future Value is $563.71 Annuity of $100 for five years at 8%: Future Value is $586.66 Increase from 4% to 6% is $22.08 Increase from 6% to 8% is $22.95….which is higher
What effect on the present value of an annuity does increasing the interest rate have? Does a decrease from 7% to 5% have the same dollar impact as a decrease from 5% to 3%?
Decreasing the interest rate (discount rate) increases the present value of an annuity. The impact is different as the discount rates get smaller. For example: Annuity of $100 for five years at 7%: Present Value is $410.02 Annuity of $100 for five years at 5%: Present Value is $432.95 Annuity of $100 for five years at 3%: Present Value is $457.97 Decrease from 7% to 5% increases PV by $22.93 Decrease from 5% to 3% increases PV by $25.02
What is the difference between an ordinary annuity and an annuity due?
An ordinary annuity has the payments at the end of the period and an annuity due has the payment due at the start of the period
What is an iterative process?
A process for arriving at a decision or a desired result by repeating rounds of analysis or a cycle of operations. The objective is to bring the desired decision or result closer to discovery with each repetition (iteration)
What does an amortization schedule tell you about a loan payment?
An amortization schedule is a complete table of periodic loan payments, showing the amount of principal and the amount of interest that comprise each payment until the loan is paid off at the end of its term. While each periodic payment is the same amount early in the schedule, the majority of each payment is interest; later in the schedule, the majority of each payment covers the loan’s principal. The last line of the schedule shows the borrower’s total interest and principal payments for the entire loan term.
Explain the meaning of this statement: The current principal balance of a loan repaid as an amortized loan is the present value of the future payment stream.
It means that in you will pay the current balance at the end of the amortization period.
If you increase the number of payments on an amortized loan , does the payment increase or decrease? why or why not?
The payment decreases because you will be paying less but more frequently.
If you increase the interest rate on an amortized loan , does the payment increase or decrease? Why or why not?
Increase because you will pay higher interest.
FV=
CF X 1=r)^n-1
_______
r
FV=
CF X (1+r)^n-1
_______
r
Interest Payment
Comment: Interest payment = r × PV = .12 × $50,000 = $6,000
