Finance Week 4 Flashcards
What are perpetuities and annuity’s?
They are time value of money equations for the stream of cash flows where all cash flows are equal sizes and occur at regular intervals
What is a Perpetuity?
Stream of future cash flows where cash flows are equal in size, occur at regular intervals and continue forever e.g. preferred stock
How do you calculate a perpetuity?
PV = C/r
What is an annuity?
Stream of future cash flows that are of equal size, occur at regular intervals and continue for a finite period of time
How do you calculate an annuity?
PV=C* (1/r-) 1/r * (1 +r)^t
What do you do if asked how much money you saved over a period of time at a certain interest rate if you deposit over time?
Calculate PV of the annuity followed by the future value of it
What is the effective interest rate?
The effective interest rate compares interest rates quoted for different periods of time (months vs years)
What is the effective annual interest rate?
EAR is the annual interest rate that accounts for compound: EAR =(1+monthly rate)^12 - 1
Why is effective annual interest rate different?
It accounts for the compounding
What is the APR?
APR = monthly rate * 12 - it is incorrect interest rate but it is used in practice
What is inflation?
Inflation is about how prices in the economy as a whole are increasing
What is the inflation rate?
the rate at which prices as a whole are increasing/
What does it mean if inflation is high?
It means that the purchasing power of money erodes
How is the inflation rate measured?
It is measured as the annual change of the Consumer Price Index (CPI)- CPI measures the # of dollars needed to buy specific basket of goods & services that represent typical family purchase
What is the difference between nominal and real interest rate?
Nominal interest rate is the interest rate at which money grows and real interest rate is rate at which purchasing power for G&S grows.
