FUND CH7 Time Value of Money

Question 1

Time Value of Money

Answer 1

Time Value of Money (TVM) is a mathematical concept that determines the value of money, at a point or over a period of time, at a given rate of interest

Question 2

Annuities

Answer 2

An annuity is a recurring cash flow, of an equal amount, and occurs at periodic (but regular) intervals

Question 3

ordinary annuity

Answer 3

first payment is at the end of a period

Calculator in “End “ mode, starts in period 1(on timeline)

Question 4

annuity due

Answer 4

first payment is at the beginning of the first period

calculator “Begin” mode starts in period 0(on timeline)

Question 5

first payment occurs at time period zero

Answer 5

annuity due

Question 6

payment occurs at time period one

Answer 6

ordinary annuity

Question 7

Uneven Cash Flows

Answer 7

When an investment or project has periodic cash flows that are not even dollar amounts or not at even intervals

Question 8

Net Present Value

Answer 8

Net Present Value (NPV) is used in capital budgeting by managers and investors to evaluate investment alternatives

NPV = Present Value of the Future Cash Flows – Cost of the Investment

– same as [PV] NPV is more flexible – nets out discounted present value [CFj] [I/YR][orange][NPV]

If NPV = 0 IRR =RR

If NPV + IRR > RR

If NPV – IRR < RR

Question 9

Internal Rate of Return (IRR)

Answer 9

is a compounded annual rate of return

an interest rate that will cause the sum of the discounted present value of all the future cash flows to equal the cost of the investment

[orange] [IRR/YR] to get % per yr or Internal Rate or Return - IRR

Question 10

Inflation Adjusted Rate of Return

Answer 10

or “Real Rate of Return” An inflation adjusted rate of return adjusts the nominal rate of return into a real (after inflation) rate of return

just less than the difference – chain mode [blue] [chain]

Question 11

Nominal interest rates

Answer 11

actual rate of return earned on an investment

Question 12

Real rates of return

Answer 12

adjusted for inflation’s impact

Real Rate of Return = [(1 + Rn) ÷ (1 + i) – 1] x 100

???Anytime inflation is involved???when to use Real return

Question 13

Rn

Answer 13

nominal rate of return or investment rate of return

Question 14

i

Answer 14

inflation rate

Question 15

Serial Payments

Answer 15

adjusted upward periodically throughout the payment period at a constant rate, usually in order to adjust for inflation’s impact Each serial payment will increase, to maintain the real dollar purchasing power of the investment

use real return (discount rate)

Question 16

Debt Repayments

Answer 16

Time value of money concepts can calculate the monthly,quarterly, or annual payment necessary to retire a debt obligation In addition to the payment required to retire the debt, the financial planner can determine the amount of interest and principal paid over a period of time ex. loans, credit cards, mortgages or car loans

Question 17

Examples of Other Practical Applications;

cash rebate vs. zero percent

pay points to reduce their mortgage payment vs. not

lump-sum payment vs. annuity

Answer 17

Should a client take the cash rebate or zero percent financing on a new car?

Should a client pay points to reduce their mortgage payment when purchasing a new home?

Should a lottery winner receive a lump-sum payment or annuity over 20 years

Question 18

Uneven Cash Flow Method good approach for what two situations

Answer 18

retirement funding calculations

education funding

Question 19

The uneven cash flow method has two steps:

Answer 19

1. Determine the net present value of the cash flow stream in today’s dollars.
2. Determine the annual savings required to fund the retirement goal

Question 20

Approach for solving TVM Calculations

Answer 20

1. Start with a timeline
2. Write down variables
3. Clear Memory
4. populate variables
5. determine periods of compounding
6. determine annuity due or ordinary annuity
7. Cash flow (+/-) —–in or out of investor’s pocket

Question 21

Periods of Compounding other then annual

Answer 21

Annual

Semi- Annual (N)x2, (i)/2

Quarterly (N)x4, (i)/4

Monthly (N)x12, (i)/12

Question 23

Solving for Term (N)

Answer 23

provides the amount of time required to accomplish financial goal or retire debt ….like the old rule of 72

Question 24

Solving for Interest Rate (I)

Answer 24

interest required to attain a certain goal

Question 25

Amortization schedule

Answer 25

Mortgage- 1) find monthly payment 2) amortization

Always end mode – make monthly {x12}

Amortize:

[1] [input] [12][orange][AMORT][=]

Life of the loan

[1] [input] [360][orange][AMORT][=]