Time value of Money Flashcards
Annuity
A finite set of level sequential cash flows.
Annuity Due
An annuity having a first cash flow that is paid immediately.
Cash flow additivity principle
The principle that dollar amounts indexed at the same point in time are additive.
Compounding
The process of accumulating interest on interest.
Default risk premium
An extra return that compensates investors for the possibility that the borrower will fail to make a promised payment at the contracted time and in the contracted amount.
Future value (FV)
The amount to which a payment or series of payments will grow by a stated future date.
Inflation premium
An extra return that compensates investors for expected inflation.
Interest rate
A rate of return that reflects the relationship between differently dated cash flows; a discount rate.
Liquidity premium
An extra return that compensates investors for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly.
Maturity premium
An extra return that compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity is extended.
Nominal risk-free interest rate
The sum of the real risk-free interest rate and the inflation premium.
Ordinary annuity
An annuity with a first cash flow that is paid one period from the present.
Quoted interest rate
A quoted interest rate that does not account for compounding within the year. Also called stated annual interest rate.
Real risk-free interest rate
The single-period interest rate for a completely risk-free security if no inflation were expected.
Simple interest
The interest earned each period on the original investment; interest calculated on the principal only.
