chapter 5

Question 1

• discount rate –

Answer 1

matches the time period of our cash flows, reflects the actual return we could earn during that period.

Question 2

The effective annual rates (EAR)

Answer 2

indicates the actual amount of interest that will be earned at the end of year. E.g. C x (1+r)n

Question 3

Annual Percentage Rates

Answer 3

indicates the amount of simple interest earned in 1 year. Interest without effect of compounding

• E.g. 6% APR with monthly comp. = 6/12 = 0.5%, 1.05^12 = 1.061678

Question 4

• Amortizing loans

Answer 4

each month you pay interest on the loan plus some part of the loan balance. i.e interest plus some principle.

Question 5

• Adjustable rate mortgages (ARMS)

Answer 5

when interest rates aren’t constant over the life of loan. Recalculated based on loan’s current outstanding

Question 6

Federal Funds rate

Answer 6

– the rate, which banks, can borrow cash reserves on an overnight basis. Used to influence very short-term IR