CHAPTER 5 (2) Time value of money

Question 1

what is compound interest and when is it used

Answer 1

used to calculate the FV of a cash flow -> means that the interest paid on the principle and on prior interest has not been paid or withdrawn

Question 2

why is compound interest different to simple interest

Answer 2

simple interest is calculated only on the principle amount -> while compound interest takes into account both the principle amount and the accumulated interest => resulting in potentially higher overall interest earnings

Question 3

what is effective annual rate of interest

Answer 3

represents the total interest you’ll earn or pay -> factoring in compounding , over a specific period => providing a more accurate measure of your financial gain or loss -> used as a comprehensive measure

Question 4

define annuity

Answer 4

a series of equal cashflows ( PMT) for a specified number of periods
* PMT = payments

Question 5

what is ordinary annuity

Answer 5

where the PMT occurs at the end of each period

Question 6

what is annuity due

Answer 6

is where the PMT occur at the beginning of each period