Chapter 4 - TVM Flashcards
Principal
the initial size of a loan
The interest remains constant. Set level of interest that occurs every period. Calculated based on the principal investment amount.
Simple Interest
Interest that grows, you earn interest on interest. If you have 2500 and then the next year that grows to x amount because of interest rate, the next period will bild interest off x, not the principal.
Compound Interest
Future Value
Investments generate interest, a sum of $100 today will be more in 4 years time because of interest. This is called compounding
Present Value
The process is called discounting. $100 dollars in 5 years time will be worth less today.
Compounding
Finding Future value
Discounting
Finding Present Value
Multiple CFs that are the same, occur at frequent intervals, for a set period of time, beginning in one periods time.
Annuity
Multiple CFs that are the same, occur at frequent intervals, for a set period of time, beginning today
Annuity Due
Multiple CFs that are the same, that occur frequently that last FOREVER beginning in one periods time
Perpetuity
Multiple CFs that grow from an initial amount that occur at frequent intervals, last FOREVER beginning in one periods time
Growing Perpetuity
Cash Flow
The net amount of cash and cash equivalents being transferred into and out of a business.
Semiannual
Twice a year
Quarterly
4 times a year
Monthly
12 Times a year
Daily
365 Times a year
A stream of cash flows that occur at consistent intervals, have the same value and occur for a set period of time
Ordinary Annuity
Annuity Checklist
- Are cash flows the same size
- Do they occur at equal intervals (eg end of every week/ year/ month)
- Do the cash flows occur for a set period of time? ( Do they have an end date)
- Do cash flows begin in one periods time?
What does M stand for
The number of compounding payments
What does C stand for
CashFlow
What is a Constant Cash flow
Like paying something off, consistent payments of a. how long or b. How much
When figuring out Constant Cash flow Present value (e.g deposit) What do you do with the ‘r’ and ‘t’ if it is semi annual?
Semi annual means 2, you divide the ‘r’ by 2 and TIMES the t by 2.
What formula would you use for: How many yearly payments of $15,000 must be made in order to pay back a mortgage of $200,000 with 4.5% interest per year?
Ordinary Annuity, Number of payments (PV) Because you already have the mortgage.
What formula would you use for: What semi-annual deposit must be made in order to accumulate $10,000 by the end of your degree (3 years) with 3.5% interest per annum?
Ordinary annuity, Constant Cash flow (FV) Because you don’t have it yet
What formula would you use for: You have accumulated a bill of $25,000 on your credit card. What monthly payment is required if you wish to repay the bill in 2 years’ time with 3% interest per annum?
Ordinary Annuity, Constant Cash flow (PV) because you already have the money.
What formula would you use for: How many yearly payments of $300 must be made in order to accumulate $5000 with 8% interest compounded annually?
Ordanairy Annuity, Number of payments (FV) Because you dont have the $5000 yet.
Annuity Dues
Stream of cash flows for a fixed period of time starting TODAY t=0.
Difference between Annuity Due and Ordinary Annuity
Annuity due formula has one more period to accumulate interest, it has (1+r) added to it
Annuity Due Checklist
Same as ordinary annuity but cash flows begin TODAY.
Constant stream of cash flows, for an INFINITE period of time, No future value as there is NO END.
Perpetuity
Perpetuity Characteristics
Only can calculate Present value and Rate of return, no future value because there is no end.
Constant stream of cash flows, that GROWS from an initial anount, forver. E.g GVMT paying students $200 p/w and increase payments by 1% p/w.
Growing Perpetuity
Working out formulas: Do cash flows start today?
If no, Lump sum. If yes, Annuity or perpetuity
Working out formulas: Do cash flows occur forever?
If yes, Perpetuity or Growing Perpetuity. If no, Ordanairy annuity or Annuity due
Working out formulas: Do payments start today? t=0
if no, ordinary annuity. If yes, Annuity due.
Types of loans:
- Interest-only loan
- Pure discount loan
- Amortized loan
Interest and principal are paid at maturity ( the end )
Pure discount loan
equal payments made each year, includes both principal and interest. At maturity principal will be paid off
Amortized loan
Interest is paid at frequent intervals, the principal is paid at Maturity.
Interest only loan
