Chapter 5 Flashcards
Why does it make sense to say that the interest rate is the price to rent money?
You really only rent money for a period of time. When you repay a loan you pay back the same amount you borrowed (the principal) plus the interest over time for holding the loan. The cost of holding the loan was the interest and like renting an apartment the interest is the rent paid for borrowing the money.
Which of the following statements about the effective annual rate and annual percentage rate is true?
EAR>APR when compounding periods per year are greater than 1. EAR=APR when compounding periods per year are = to 1. EAR can never be less than APR.
When you increase the number of payments per period why does the total cash payments times the number of payments in the period not equal the original single payment for the period?
The payment includes the interest plus principal amount. when you increase the number of payments you decrease the principal amount and since the interest is based of the outstanding principal it will decrease as well as the annuity.
Explain why the real interest rate is the reward for saving?
The real rate is the increase of purchasing power over the period. The additional goods and services you can purchase are a reward for not consuming at a earlier point in time.
What does the term risk free interest mean?, and why do we usually use the U.S treasury bill yield as the risk free rate?
Guaranteed interest that is paid off at the end of contract. We assume the Government will not default on any issued treasury bills so there is only one pay off.
