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FN1 corporate finance > Chapter 5: Time value of money > Flashcards

Chapter 5: Time value of money Flashcards

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1
Q

what does time value mean for money

A

it can be invested today and be worth more tomorrow

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2
Q

what is the opportunity cost of money

A

the interest rate that would be earned by investing it

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3
Q

what is the discount rate also called

A

required rate of return (k)

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4
Q

what do you need to make time value decisions

A

identify the relevant discount rate you should use

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5
Q

what is simple interest

A

interest paid or received only on the initial investment (principal)
- the same amount of interest is earned each year

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6
Q

what is compound interest

A

interest that is earned on the principal amount and on the future interest payments

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7
Q

how do you calculate FV on financial calculator

A

PV = - , I/y, n, cpt FV

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8
Q

what is discounting also called

A

computing for PV

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9
Q

what does PV or discounting mean

A

asking how much will a person need to invest today at that interest rate to have $xxx in so many years``

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10
Q

what is of exchange

A

something that can be used to facilitate transactions
money in a sense represents out ability to buy goods and services, that is it operates s a medium of exchange and has no value in and of itself.

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11
Q

what is the compound value interest factor (CVIF)

A

a term that represents the future value of an investment at a given rate of interest and for a stated number for periods (1 + K)to the power of n
- basic compounding equation

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12
Q

what is basis point

A

1/100 of 1 percent is a basis point

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13
Q

what happens when earning just a few basis points more on one investment

A

causes the future value of the portfolio to compound that much faster

  • just be careful not underestimate the associated risks, it can cause you to loose big
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14
Q

what is discounting

A

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

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15
Q

what is present value interest factor (PVIF)

A

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

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16
Q

if people don’t want to pay in the full price for something, they ask for a discount
so $1 million in 40 years is

A

in the same way, $1 million dollars in 40 years is not worth $1 million today, so you discount or take something off to get it to its true value

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17
Q

the discount factors (PVIF) are always less than one as long as

A

discount rates are positive k is greater than 0
this means that future dollars are usually worth less than the same dollars today
- this is not always the case (pay german gov. to lend them money)

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18
Q

the greater the discount rate, the

A

greater the CVIF and future value
and
the smaller the PVIF and present value
and vice versa

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19
Q

consider low interest rates on pension funds, what happens when interest rates are low

A

based on discounting these future pension payments using current interest rates
- as a result of very low interest rates, the PV of these pension liabilities has increased dramatically

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20
Q

volatile (and largely negative ) capital market returns hit pension funds how

A

on both sides of their funding equation

  • resulted in major funding issues
  • the effect of these low interest rates, combined with poor investment returns has meant that many defined-benefit pension plans have significant deficits as their assets have not increased as fast as the PV of their lia bilities
21
Q

Time or “holding” Periods

A

how long do we need to invest 20, 00 at 10% to get 31,000

22
Q

how do you calculate the holding period or time when you invest 20,000 at 10% to get 31,000?

A 
0 PMT
31,000 FV
-20,000 PV
10 I/Y
CPT N = 4.5982 or 4.6 years
23
Q

what is the rate of return

Price is 20,000 invesetment that has a payoff of 31,000 in 5 years

A 
0 PMT
31,000 FV
-20,000 PV
5 N 
CPT I/y 9.16 rate of return
24
Q

what is interest rate also called

A

rate of return

25
Q

what does discounting ask

A

how much will aperson need to inveset today at that interest rate to have a certain amount in 40 years

26
Q

what is an ordinary annuity

A

series of equal payments over a fixed amount of time

- payments are mde at the END of each period

27
Q

assuming a player earning an average of 2.4 million decides to invest 10% which is $141,600 at the END of each year for the next 6 years and expects to earn 8% per year. how much will the have at the end of 6 years

A 
141,600 PMT
6 N
0 PV (no deposit today) 
9 I/y
CPT FV = 1,038,768
28
Q

what are Annuities due

A

payments are made at the beginning rather than the end of each year (set calculator to BGN mode)

29
Q

assuming a player earning an average of 2.4 million decides to invest 10% which is $141,600 at the Beginning of each year for the next 6 years and expects to earn 8% per year. how much will the have at the end of 6 years

A 
2nd BGN 2nd set 
141,600 PMT
6  n
0   pv
8 I/y
CPT FV = 1,121,869
30
Q

what are perpetuities

A

special annuities in that they go on forever
- so n gets to infinity in the annuity equation
use 1000 as your place holder for time?

31
Q

definition of an annuity

A

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

32
Q

definition of cash flows

A

the actual cash generated from an investment

33
Q

definition ordinary annuity

A

equal payments that are made at the end of each period

34
Q

definition of lessee

A

a person who leases an item

35
Q

definition of annuity due

A

an annuity (such as a lease) for which the payments are made at the beginning of each period

36
Q

what is the nominal rate

A

quoted rate

37
Q

what is effective interest rate

A

the rate at which a dollar invested grows over a given period, usually stated in % terms based on an annual period
- looking at the rate alone is not enough it is important to look at the compounding frequency

38
Q

as the frequency of the compounding increases,

A

the effective annual rate also increases

39
Q

how do you calculate the effective interest rate with a quoted rate of 12% compounded annually

A 
2nd Iconv, 2nd clrwork 
NOM - enter 12 (quoted rate)  enter down arrow down arrow
C/Y = 1 compounded annually 
enter down arrow down arrow
EFF = CPT = 12.747%
40
Q

how do you calculate the effective interest rate with a quoted rate of 12% semi annually

A

2nd iconv, 2nd clrwork
NOM = 12 enter down arrow down arrow
C/Y = 2 enter down arrow down arrow
EFF = CPT = 12.36%

41
Q

how do you calculate the effective interest rate with a quoted rate of 12% compounded continuously

A

0.12
2nd ex
-1
= 12.75%

42
Q

definition of mortgage

A

a loan, usually secured by real property, that involves “blended” equal payments (both interest and a principal repayment) over a specified payment period

43
Q

definition amortize

A

to retire a loan over a given period by making regular payments
the balance at the end of the term will be zero

44
Q

what can a mortgage be viewed as and why

A

an annuity
because these loans involve equal payments at regular intervals, based on one fixed interest rate specified when the loan is taken out, the payments can be viewed as annuities

45
Q

what does an amortization schedule do

A

it divides the blended payments into the interest portion and the principal repayment portion
important for business because
- interest portion is a deductible expense for tax purpsoes.

46
Q

for mortgages how is the interest portion determined

A

by applying the effective period interest rate to the principal outstanding at the beginning of each period
- the remaining portion of the payment is used to reduce the amount of principal outstanding

47
Q

how are mortgages in Canada compounded

A

semi-annually , similar to bonds

48
Q

payments on mortgages can be made

A

at least monthly

49
Q

what is the term of a mortgage payment

A

the period for which investors can “lock in” at a fixed rate (usually shorter than the actual period to repay the amount in full)

FN1 corporate finance (44 decks)

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