Lecture 2

Question 1

Present Value

Answer 1

Current value of a future cash flow

Question 2

Future Value

Answer 2

Amount to which an investment will grow after earning interest

Question 3

Principal

Answer 3

Original amount of money

Question 4

Risk premium

Answer 4

Is the additional return an investor expects to earn from an investment to compensate for the higher risk compared to a risk free asset

Question 5

The Discount Factor

Answer 5

• Is a multiplier that reduces the future value of cash flows to their present value
• It measures the present value of 1 unit of currency received at the end of year t

Question 6

Perpetuity

Answer 6

Is a financial concept in which a cash flow is theoretically received forever (in perpetuity)

Question 7

Perpetuity Due

Answer 7

If the perpetuity starts immediately it is called perpetuity due

Question 8

Growing perpetuity

Answer 8

Is a cash flow stream which will continue indefinitely with the cash flow amount increasing at a constant rate

Question 9

Annuity

Answer 9

An annuity is an asset that pays a series of identical payments made over a period of years e.g. house mortgage

Question 10

Annuity factor

Answer 10

• Is the cumulative impact of multiple discount factors for equal periodic payments
• Is derived by summing the discount factors for each period within the annuity

Question 11

Annuity due

Answer 11

• An annuity due is a financial arrangement when a series of equal payments or cash flows are made or received at the beginning of each period rather than at the end
• The level stream of payments starts immediately e.g. most lease or rental agreements

Question 12

A Growing Annuity

Answer 12

A finite stream of cash flows (for t years) growing at a rate g

Question 13

Amortising Loan

Answer 13

• Is repaid in regular instalments covering both principal and interest, reducing the outstanding balance over time
• In amortizing loans, the monthly payments are fixed, but the proportion of interest and principal
  changes over time
• At the start, the loan balance is higher so a larger portion of the payment goes toward interest
• As the balance decreases the interest portion reduces and more of the payment goes toward the principal

Question 14

Continuous Compounding

Answer 14

• This describes a situation where payments are spread evenly and continuously throughout the year so the interest rate is continuously compounded
• Continuous compounding is a theoretical concept as it assumes that interest is compounded an infinite number of times per unit of time rather than discrete intervals e.g. annually, quarterly or daily