Concepts (CH 1): Time Value of Money Flashcards
T or F. The Concept of compound interest or interest on interest is deeply embedded
in TVM procedures
T
The growth in the value of the investment from period to period that reflects not only the interest earned but also the interest earned on the previous period’s interest
earnings
compound interest
value of an investment’s cash flows as a result of the effects of compound interest (projects the cash flow forward)
future value
why is measuring PV and FV important?
- it is useful when comparing investment alternatives
- the value of the investment’s cash flow must be measured at some common
- point in time
- at the end of the investment
horizon (FV) or - at the beginning of the investment
horizon (PV)
brings the cash flows from an
investment back to the beginning of the investment’s life based on an
the appropriate compound rate of return
present value
a diagram of the cash flows associated
with a TVM problem
TIME LINES
a cash flow that occurs in the present/today is at ________; cash outflow/payments has _________; and the cash inflows/receipts has ____________.
time zero; negative
sign; positive sign
measure of the time value of money, though risk differences in financial securities cause differences in equilibrium interest rates
requird rates of return, discount rates, or opportunity costs
required rate of return for a particular investment
equilibrium interest rates
- theoretical rate on a single-period loan that has no expectation of inflation in it
- refers to an investor’s increase in purchasing power (after adjusting for inflation)
real risk-free rate
what are the different types of risk
default risk, liquidity risk, mturity risk
default risk
risk that a borrower will not make the promised payments in a timely manner
liquidity risk
risk of receiving less than fair value for an investment if it must be sold for cash quickly
t or f.
- prices of long-term bonds are more volatile than those shorter-term bonds
- longest maturity bonds have more maturity risk than shorter-term bonds and require a maturity risk premium
represents annual rate of return actually being earned after adjustments have been made for different compounding periods
Effective annual rate (EAR)
Future Value is the amount to which a __________ will __________ when it is placed in an account paying compound interest
current deposit; grow over time
today’s value of a cash flow that is to be received in the future
Present value of single sum
stream of equal cash flows that occurs at equal intervals over a given period
annuities
2 types of annuities
ordinary annuities & annuity due
most common type of annuity
- characterized by cash flows that occur
at the end of each compounding period
ordinary annuities
payments occur at the beginning of each period
annuity due
financial instrument that pays a fixed amount of money at set intervals over an infinite period of time
perpetuity
process of paying off a loan with a series of periodic loan payment, whereby a portion of the outstanding loan amount is paid off with each payment
loan amortization
there are many TVM applications where it is necessary to determine the size of the deposit that must be made over a specified period in order to meet a future liability
what are these applications? m
- setting up a funding program for
future college tuition - the funding of a retirement program.
