Chapter 5: Time value of money Flashcards
future value
The value at a given future
date of an amount placed on
deposit today and earning
interest at a specified rate.
compound interest
Interest that is earned on a
given deposit and has become
part of the principal at the end
of a specified period.
principal
The amount of money on which
interest is paid.
present value
The current dollar value of a
future amount—the amount of
money that would have to be
invested today at a given
interest rate over a specified
period to equal the future
amount.
discounting cash flows
The process of finding present
values; the inverse of
compounding interest.
annuity
A stream of equal periodic
cash flows over a specified
time period. These cash flows
can be inflows of returns
earned on investments or
outflows of funds invested to
earn future returns
ordinary annuity
An annuity for which the cash
flow occurs at the end of each
period.
annuity due
An annuity for which the cash
flow occurs at the beginning of
each period.
perpetuity
An annuity with an infinite life,
providing continual annual
cash flow.
mixed stream
A stream of unequal periodic
cash flows that reflect no
particular pattern.
semiannual compounding
Compounding of interest over
two periods within the year
quarterly compounding
Compounding of interest over
four periods within the year
continuous compounding
Compounding of interest an
infinite number of times per
year at intervals of
microseconds.
nominal (stated) annual rate
Contractual annual rate of
interest charged by a lender
or promised by a borrower.
effective (true) annual rate
(EAR
effective (true) annual rate
(EAR
annual percentage rate
The nominal annual rate of
interest, found by multiplying
the periodic rate by the
number of periods in one year,
that must be disclosed to
consumers on credit cards and
loans as a result of “truth-in
lending laws.”
annual percentage yield
(APY)
The effective annual rate of
interest that must be disclosed
to consumers by banks on their
savings products as a result of “truth-in-savings laws”
loan amortization
The determination of the equal
periodic loan payments
necessary to provide a lender
with a specified interest return
and to repay the loan principal
over a specified period.
loan amortization schedule
A schedule of equal payments
to repay a loan. It shows the
allocation of each loan
payment to interest and
principal.
