Lectur 6 (chapter 5) Flashcards
What is compound interest?
Interest on interest. Saving in an account during a few years.
C * (1+r)^n
We earn compound interest rate since we also earn interest on what we earned in interest last year.
EAR?
r?
PV?
FV?
c?
Effektive annual rate
interest / discount rate
Present value
Future value
Cash flow
APR?
k?
Rr?
i?
Annual percentage rate
number of compounding periods per year
real interest rate
rate of inflation
NPV?
Cn?
n?
Rn?
t?
Net present value
Cash flow that arrives in period n
Number of periods
interest / discount rate for an n-year term
tax rate
What’s the difference between APR and EAR?
Annual percentage rate doesn’t include the effect of compounding interest. Effective annual rate does.
Factors affecting interest rates:
- Supply and demand on bonds
- Government, if they use monetary policy
- Inflation, a high inflation results in less purchasing power. Measure by looking at CPI
Real interest rate=
Rate without inflation accounted.
= rr
Nominal interest rate =
The actual rate that is payed or earned to the bank
= r
What is a yield curve? What can it be used for?
Avkastningskurva. Shows the relationship between the length and rate of a loan.
It can be used as a forecasting tool since the slope tells something about the future economy.
How to attract investors?
Set a long-term rate that is higher than the short term-rate.
How should we invest given the yield curve?
If the short-term rate is expected to increase and the long term rate is under or equal to short term rate, it’s better to invest short term and wait for interest rates to increase.
Fisher effect?
Nominal rate increase when inflation also increase. This is not obvious since nominal rate normally not responds to inflation on short term.
