Module 4 - Time Value of Money Flashcards
what is the TVM concept?
it is better to receive money sooner than later. You can invest the money that you have today, producing more money tomorrow.
what is a timeline
it depicts the cash flows associated with a given investment
what is the lender’s pov?
the compensation for lending funds
what is the borrower’s pov?
the cost of borrowing funds
In the lender’s pov, what is interest?
interest is the lender’s compensation for lending funds. it is recorded as interest income
in the borrower’s pov, what is interest?
interest is the cost of borrowing funds which will be recorded as interest expense
what is simple interest?
you don’t earn interest on interest
what is compound interest?
a depositor earns interest on interest
how do you compute compound interest
the interest in he first compounding period is added on the principal, which will then be the basis for the interest to be computed for the next period
three basic patterns of cash flow
- single amount
- annuities
- mixed stream
this refers to the lump sum amount that you currently hold, or you expect to receive in the future
Single Amount
interest is also known as
time value of money
this is the mount you have to invest today if you want to have a certain amount of cash flow in the future
Present Value
the amount to which an investment will grow after earning interest
Future Value
the future value is computed by ___________ while the present value is computed by ___________
compounding; discounting
the future value technique uses _________ to find the future value of each cash flow at the end of the investment’s life and then sums these values to find the investment’s total future value
compounding
the present value technique uses ___________ to find the present value of each cash flow at time zero and then sums these values to find the investment’s total value today
discounting
what do investors use in practice? compounding or discounting?
when making investment decisions, investors usually adopt the discounting or the present value approach. they are ore concerned with possible cash lows today because they have to decide today
what do you use to estimate how many years it will take to double your money?
by using the Power of 72 r (or i) is expressed as a whole number
it is a stream of equal periodic cash flows over a specified time period
annuities
what are the two basic types of annuities?
Ordinary annuity and Annuity due
payments or receipts occur at the end of each period
Ordinary Annuity
Annuity Due
Payments or receipts occur at the beginning of each period
which annuity is cash flow received sooner?
Ordinary Annuity
this annuity would have a higher future value than the ordinary annuity because of each of its five annual cash flows can earn interest for 1 year more than each of the ordinary annuity’s cash flows
annuity due
True or False: the value (present or future) of an annuity due is always greater than the value of an otherwise identical ordinary annuity
True
It is an annuity with an infinite life, providing continual annual cash flow;
Perpetuity
with this, the periodic annuity or cash flow stream continues forever
Perpetuity
with this, the periodic annuity or cash flow stream continues forever
Perpetuity
it is the unequal periodic cash flows that reflect no particular pattern
Mixed Stream
the opposite of annuity
Mixed Stream
True or False: the effective interest rate is greater than the nominal (annual) interest rate. and the effective rate of interest will increase the more frequently interest is compounded
True
one-half of the stated rate is paid twice a year
Semiannual compounding
one-half of the stated rate is paid twice a year
Semiannual compounding
one-fourth of the stated interest rate is paid four times a year
Quarterly compounding
True or False: The more frequently interest is compounded does not necessarily mean the greater the amount of money is accumulated
False
it is the contractual annual rate of interest charged by a lender or promised by a borrower
Nominal (stated) annual rate
it is the annual rate of interest actually paid or earned
Effective (true) annual rate
