Chapter 5 Flashcards
What is the relationship between discount rate and present value?
lower discount rate means higher present value
Time Value:
What is the FV of Lump Sum calculation?
FV = PV * [(1+i)^n]
where i = interest, n = # of terms
Time Value:
What is the PV of Lump Sum calculation?
PV = FV * [1/((1+i)^n)]
where i = interest, n = # of terms
You invest $5,000 in a CD (certificate of deposit) today. The CD earns 2% interest and has a term of 5 years. How much will you receive at the end of 5 years?
a) Is this a PV or FV problem?
b) Write the formula for the solution:
a) FV
so use FV = PV * [(1+i)^n]
b) FV = 5,000 * (1+.02)^5
You will receive a lump sum payment of $500,000 in three years. The market interest rate is 3%. What is the value of that payment today?
a) Is this a PV or FV problem?
b) Write the formula for the solution:
a) PV
so use PV = FV * [1/(1+i)^n]
b) PV = 500,000 * [1/((1+.03)^3)]
Components of payments (how it changes over time):
Payment - ___1___
Interest - ___2___
Principal reduction/paydown - ___3___
Outstanding balance/ Balance ending - ___4___
1) stay the same
2) decrease
3) increase over time
4) decreasing at a faster rate in the later year
EAR, abbreviated EFF%
is also called the equivalent annual rate (EAR). This is the rate that would produce the same future value under annual compounding as would more frequent compounding at a given nominal rate.
EAR Equation is
EAR =[ (1 + [Inom/m)]^m ] - 1
where:
Inom = nomminal rate
m = # of compounding periods per year
What is the difference between:
- Ordinary Annuity
- Annuity Due
- Ordinary Annuity - FUTURE
2. Annuity Due - NOW
Lump Sums:
1) When interest rate ↑
2) When interest rate ↓
3) Term ↑
1) PV Lump Sum ↓ and FV Lumpsum ↑
2) PV Lump Sum ↑ and FV Lumpsum ↓
3) PV Lump Sum ↓ and FV Lumpsum ↑
Annuity:
1) When interest rate ↑
2) When interest rate ↓
3) Term ↑
1) PV Lump Sum ↓ and FV Lumpsum ↑
2) PV Lump Sum ↑ and FV Lumpsum ↓
3) PV Lump Sum ↓ and FV Lumpsum ↑
