Mod 6 Flashcards
Annual Percentage Rate
A nominal simple interest rate that banks are required by law to state on loans
Annual Percentage Yield
A nominal interest rate that reflects all the compound interest paid or earned in one year
Basis Point
A unit that is equal to 1/100 of 1%
0.0001 or .01%
Certificate of Deposit
A savings certificate issued by a bank entitling the holder to receive interest for a specified term
Compound Interest
Interest earned on both the initial principal and the reinvested interest earned in prior periods
Consistent
Periodic rate and # of periods are both defined over the same unit of time (TVM calculations)
Continuously Compounded Interest
Interest paid constantly, and immediately begins earning interest on itself
Decimal Form
Interest rate expressed as a % must be converted into decimal form when using mathematical formulas or excel spreadsheets for TVM calculations
Discounting
Determining the present value of an expected future cash flow using the discount rate
Effective Rate
A low frequency rate that is equivalent to a high frequency rate
Example: 1% monthly = 12% annually
Future Value
Value of a cash flow that occurs later than the present value
Inflation
General increase in prices and a fall in the purchasing power of money
Interest on Interest
Interest earned on prior interest payments becoming principal
Internal Rate of Return
Discount rate used in capital budgeting that makes the NPV of all cash flows from an investment equal 0
Rate of return you expect to receive if you put your money into a project
IRR Rule
Accept projects when IRR is greater than opportunity costs
Reject if IRR is less than opportunity costs
Lump Sum
A single amount of money at a certain time
Net Present Value
Difference between the present value of cash inflows and the present value of cash outflows
Net Present Value Rule
Accept all investments that are positive NPV because they create value
Reject all investments that are negative NPV because they destroy value
Nominal Interest Rate
% change in dollars per period
Desired rate of return + adjustment for inflation
Number of Periods
Number of periods between two lump sums
Percentage Form
Used to input interest rates when solving TVM calculations with a financial calculator
Periodic Rate
Interest rate defined in a contract that specifically states how much interest is earned or paid over an interval of time
Present Value
Value of a cash flow that occurs earlier than the future value
Real Interest Rate
% change in purchasing power for a given period
Approximately the nominal interest rate - inflation rate
Simple Interest
Interest an investment earns on original principal only
Treasury Bill
Short term debt obligation issued and backed by US government with a maturity of less than 1 year
