Chapter 5 And 6 Flashcards
Introduction of valuation: the time value of money
Future value (FV)
Cash value of an investment at some time in the future
Compound interest
Compound interest is when we earn interests also on interests, process is called compounding
Compounding interest formula
FV = C0 * (1+r)^t
Present value
PV = FV / (1+r)^t
What is present value of future cash flow called?
Discounted cash flow (DCF) valuation
Discount (or interest) rate, (rate of) return
r = (FV/PV)^1/t - 1
Lump sum
an amount of money that is paid in one large amount on one occasion
Annual percentage rate (APR)
The Annual Percentage Rate (APR) is a measure of the interest rate plus the additional fees charged with the loan.
APR=m*r
Effective Annual Rate (EAR)
Annual Percentage Yield (APY)
The true interest that is being charged or earned.
EAR=(1+(r/m))^m - 1
EAR=(1+(APR/m))^m - 1
Differences between APY and APR
APY: determines what you earn; used to calculate what you can earn on your money on deposited accounts; computes using compound interest; the higher the APY the higher the total return on investment.
APR: determines what you pay; used to calculate the cost of borrowing for loans or credit cards; calculated with any fees or charges; the lower the APR the less extra you pay out of your pocket.
Differences between APY and APR
APY: determines what you earn; used to calculate what you can earn on your money on deposited accounts; computes using compound interest; the higher the APY the higher the total return on investment.
APR: determines what you pay; used to calculate the cost of borrowing for loans or credit cards; calculated with any fees or charges; the lower the APR the less extra you pay out of your pocket.
Perpetuity
A perpetuity is a constant steam of identical cash flows with no end, also called consols
Present value of perpetuity
PV = C/r
Annuities
An annuity is a series of constant cash flows that occur at the end of each period for some fixed number of periods
Present value for annuity cash flows
PV = C/r * (1-(1/(1+r)^t))
Future value for annuities
FV = PV * (1+r)^t = C/r * ((1+r)^t -1)
Future value for annuities
FV = PV * (1+r)^t = C/r * ((1+r)^t -1)
Growing perpetuities
Growth rate denoted by g
PV=C/r-g
Pure discount loan
Simplest form if loan, the borrower receives money today and repays simple lump at the end
Interest only loan
The borrower pays interest each period and repays the original amount at the end.
Amortized loans
The borrower pays interest and parts of the principal amount in each period. 2 basic types:
Evenly (fix) principal portions: the principal portions of the loan repayment are fixed and interest portions are changing every period.
Annuity repayments: the repayments are fixed
