Quiz 2 Review Flashcards
PV
With how much money am I starting (do I need to start)?; The current dollar value of a future amount-the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount.
FV
How much money will I have (do I want) at the end?; The value at a given future date of an amount placed on deposit today and earning interest at a specified rate.
Three Basic Patterns of Cash Flows
A single amount: A lump sum amount either held currently or expected at some future date.
An annuity: A level periodic stream of cash flow.
A mixed stream: A stream of unequal periodic cash flows
Compound Interest
Interest that is earned on a given deposit and has become part of the principal at the end of a specified period.
Principal
the amount of money on which interest is paid
Discounting Cash Flows
the process of finding present values; the inverse of compound interest
Ordinary (Deferred) Annuity
an annuity for which the cash flow occurs at the end of each period
Annuity Due
an annuity for which the cash flows occur at the beginning of each period
Perpetuity
an annuity with an infinite life, providing continual annual cash flow
Continuous Compounding
involves the compounding of interest an infinitive number of times per year at intervals of microseconds
Rule of 72
A technique for estimating the number of years required to double your money at a given rate of return (multiples that equal 72)
Rule of 115
A technique for estimating the number of years required to triple your money at a given rate of return (multiples that equal 115)
Bonds
Long-term debt instruments issued by companies, federal government, and state/local government
Bond Characteristics
- Fixed promise-to-pay
- First position for cash flows in case of liquidation
- Lower relative risk to the bondholder
- Lower relative rate of return (safer)
Factors Influencing Equilibrium Interest Rate
inflation, risk, liquidity preference
Inverted Yield Curve
expect rates to decline in the future because they expected inflation to decline (downward slopping)
Flat Yield Curve
an expectation of moderating inflation offsets the requirements for a higher rate to compensate for tying up cash
Normal Yield Curve
no change is expected in inflation; the requirement for a higher interest rate to compensate for tying up cash for a longer term shows through
Corporate Bonds
a long-term debt instrument indicating that a corporation that borrowed a certain amount of money and promises to repay it in the future
Coupon Interest Rate
the percentage of a bond’s par value that will be paid annually, typically in two equal semiannual payments, as interest
Par Value (FV)
The amount borrowed by the company and the amount owed to the bond holder on the maturity date (never changes)
Bond Maturity Date
The time at which a bond becomes due and the principal must be repaid
Interest Rate Risk
The chance that interest rates will change and thereby change the required return and bond value
Yield to Maturity (YTM)
The rate of return that investors earn if they buy a bond at a specific price and hold it until maturity
