chapter 5 book: Time Value of Money

Question 1

time value of money

Answer 1

the idea that a dollar today is worth more than a dollar in the future

Question 2

medium of exchange

Answer 2

something that can be used to facilitate transactions

Question 3

The opportunity cost of money

Answer 3

the interest rate that would be earned by investing it

what we would get instead of just holding it like wankers

basically, the price of money

Question 4

required rate of return or discount rate

Answer 4

the market interest rate

Question 5

Simple interest

Answer 5

interest paid or received on only the initial investment (the principal)

Question 6

the formula to calculate simple interest

Answer 6

Value (time n) =

P + (n × P × k)

P: principal

n: number of periods
k: interest rate

Question 7

compound interest

Answer 7

interest that is earned on the principal amount invested and on any accrued interest

amount of interest earned increases every year or period

we reinvest the amount we have year after year

Question 8

reinvesting

Answer 8

continuing to invest principal as well as interest each year

Question 9

formula for future value using compound interest

Answer 9

FV = PV · (1 + k)^n

FV: future value

PV: present value

k: interest rate
n: number of periods

Question 10

future value interest factor (FVIF)

Answer 10

a term that represents the future value of an investment at a given rate of interest and for a stated number of periods

(1 + k)^n

always less than one if k is positive

Question 11

basis point

Answer 11

1/100 of 1 percent

Question 12

why do finance experts focus so much on basis points?

Answer 12

because of compound interest

small and even minimal differences in interest rates can makes huge differences in many many years

Question 13

discounting

Answer 13

determining present values

finding the present value of a future value by accounting for the time value of money

Question 14

formula for finding present value using the time value of money

Answer 14

PV = FV / (1 + k)^n

FV: future value

PV: present value

k: interest rate
n: number of periods

Question 15

discount factor or present value interest factor (PVIF)

Answer 15

1 / (1 + k)^n

a formula that determines the present value of $1 to be received at some time in the future, n, based on a given interest rate, k

Question 16

what do we mean when we say that PVIF and FVIF are reciprocals?

Answer 16

the greater the discount rate, the greater the FVIF (and future value) and the smaller the PVIF (and present value), and vice versa

Question 17

annuity

Answer 17

a series of payments or receipts (cash flows)

regular payments on an investment that are for the same amount and are paid at the same interval of time

Question 18

cash flows

Answer 18

the actual cash generated from an investment

Question 19

Ordinary annuities

Answer 19

involve end-of-period payments

equal payments that are made at the end of each period of time

Question 20

lessee

Answer 20

a person who leases an item

Question 21

annuity due

Answer 21

cash flows are paid at the beginning of a period

ex: a lease

Question 22

perpetuity

Answer 22

a special annuity that provides payments forever

Question 23

formula of present value of normal perpetuity

Answer 23

PV = PMT / k

Question 24

formula of present value of growing perpetuity and needed conditions for it to work

Answer 24

PV = PMT / (k - g)

g: constant rate per period
1. only works when k > g
2. Only future estimated cash flows and estimated growth in these cash flows are relevant
3. The relationship holds only when growth in payments is expected to occur at the same rate indefinitely

Question 25

formula of present value of growing annuity

Answer 25

its the same as the growing perpetuity but the last payment occurs at time n, that is, the payments do not go on to infinity

PV =

(PMT / (k - g)) ·
[1 - ((1 + g)/(1 + k))^n]

Question 26

The effective rate for a period

Answer 26

the rate at which a dollar invested grows over that period

It is usually stated in percentage terms based on an annual period

Question 27

formula to find the effective rate

Answer 27

k = (1 + (QR / m))^m - 1

k: effective rate

QR: quoted rate

m: number of compounding periods per year

Question 28

formula to find the effective rate when compounding is conducted on a continuous basis

Answer 28

k = e^QR − 1

Question 29

mortgage loan

Answer 29

involves “blended” equal payments (both interest and a principal repayment) over a specified payment period

involves usually an amortized loan

for real assets such as properties

compounded semi annually (In Canada)

Question 30

amortization

Answer 30

killing a loan over a given period by making regular payments

payments can be viewed as annuities

Question 31

does the principal payment increase or decrease each period?

what about interest payment?

why tho?

Answer 31

principal payment increases each period because the total payment stays the same but the interest payments decrease

interest payments decrease because the total amount outstanding decreases after each payment

interest are higher at the beginning because the cost of borrowing money is higher at the beginning

Question 32

the term of a loan

Answer 32

refers to the period for which investors can “lock in” at a fixed rate

interest rates on the mortgage can change after the term ends

usually shorter than the period over which the loan is to be repaid, or amortized

Question 33

amortization period

Answer 33

he period over which the loan is to be repaid, or amortized

Question 34

formula to find the mount you pay of interest (excluding principal payment) on mortgage payments

Answer 34

k monthly =

(1 + (k / 2))^(2 / 12) - 1