Chapter 6

Question 1

What is annuity?

Answer 1

finite series of equal payments that occur at regular intervals

• ordinary annuity: If the first payment occurs at the end of the period
• annuity due: If the first payment occurs at the beginning of the period (not relevant)

Question 2

What is perpetuities?

Answer 2

infinite (never ending) series of equal payments
- Common traits:
• Constant payments
• Regular intervals
Difference:
• finite vs. infinite number of payments

Question 3

What is the effective annual rate (EAR)?

Answer 3

This is the actual rate paid (or received) after accounting for compounding that occurs during the year
If you want to compare two alternative investments with different compounding periods, you need to compute the EAR and use that for comparison

Question 4

What is the annual percentage rate (APR)?

Answer 4

This is the annual rate that is quoted by law; The interest rate charged per period multiplied by the number of periods per year
APR = period rate * the number of periods per year
• You should NEVER divide the effective rate by the number of periods per year – it will NOT give you the period rate