Chapter 9 - The Time Value of Money: Compounding & Discounting Flashcards
Compounding
the ability of an asset to generate earnings that are then reinvested and generate their own earnings. The process of going from a value today to an expected buy unknown value in the future
Discounting
to multiply a number by a rate less than one
Positive Interest Rates
relates to the idea that “A dollar today is worth more than a dollar tomorrow”
Risk Aversion
relates to the idea that “A safe dollar is worth more than a risky one.” Investors are risk averse, and would rather have lower risk associated with their investments
Present Value
the amount that a future sum of money is worth today given a specified rate of return
Future Value
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today. The amount an investment is expected to grow to at some future date
Compound Interest
When an investment earns interest on both the original principal and the accumulated interest, or interest earned on interest
Compound Rate
The rate at which an investment is compounded, used to determine the ability of an asset to generate earnings that are then reinvested and generate their own earnings
Growth Rate
The variables r or i used in the compounding rate, the opportunity cost of capital or the return that is a hurdle rate for the investment
Interest Rate
The variables r or i used in the compounding rate, the opportunity cost of capital or the return that is a hurdle rate for the investment
Yield
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today. There are two ways to calculate FV: compound frequency and future value factor
Compounding Frequency
The variable n, or the number of times the investment is compounded
Future Value Factor
the number by which you multiply the present value of an investment to arrive at the future value of an investment
Simple Interest
Earning interest only on the original deposit in the account, when an investment pays interest only on the original principle
Rule of 72
A simple and inexact rule of thumb that provides a quick estimate of the yield on a single (one time) investment. Divide the number 72 by the interest rate to get the number of years in which the investment will double
Single Period Investment
A one time investment
Multiple Period Investment
An investment that is added to over a period of time
Rate of Return
The gain or loss of an investment over a specified period, expressed as a percentage increase over the initial investment cost. Gains on investments are considered to be any income received from the security, plus realized capital gains
Effective Annual Rate
The interest rate that is annualized by using the compound interest earned on an investment
Annual Percent Rate
The interest rate stated in annual or yearly terms
Marginal Tax Bracket
The amount of tax paid on an additional dollar of income. As income rises, so does the tax rate.
After-Tax Rate of Return
the rate of return earned on an investment after taxes are paid on the investment. The after-tax rate of return is highest on municipal bonds
Discount Rate
the rate used to calculate the present value of a future cash payment
Discount Factor
The equation 1/(1+r), values that give the present value of a dollar that you are expected to receive at some time, n, in the future, discount at a rate, r
