Quiz 2

Question 1

Difference between compounding and discounting

Answer 1

Compounding - used to find future value

Discounting - used to find present value

Question 2

Simple interest vs. Compound interest

Answer 2

Simple - interest on principle only

Compound - interest on interest

Question 3

What happens to the present value of future cash flows if the discount rate increases? Decreases?

Answer 3

Increases - PV decreases

Decreases - PV increases

Question 4

What is the present value factor? What is the future value factor?

Answer 4

present value factor is used to calculate the present value per dollar that is received in the future.

future value factor is used to calculate the future value of an amount per dollar of its present value

Question 5

What is the rule of 72? (memorize its equation)

Answer 5

How long it will take to double your money at a given interest rate
72/Interest rate = Time to double investment

Question 6

What is a nominal interest rate? What is the difference between a simple interest rate and an effective annual interest rate? (memorize equation for EAR)

Answer 6

Nominal = in name only, Nominal can also refer to the advertised or stated interest rate on a loan.
Simple interest is a quick method of calculating the interest charge on a loan
effective annual interest rate is the interest rate that is actually earned or paid on an investment, due to the result of compounding over a given time period.

Question 7

What is an annuity? What is the difference between an ordinary annuity and an annuity due?

Answer 7

annuity - level stream of cash flows over a period of time
Ordinary - paid at end of month
Due - paid at beginning, higher PV and FV

Question 8

What is a perpetuity? (memorize its equation)

Answer 8

an annuity but goes on forever