Time Value of Money

Question 1

Interest Rate

Answer 1

Rate of return that reflects the relationship between differently dated cash flows. Interest rates can be thought of in three ways:

▪️Required rate of return
▪️Discount rate
▪️Opportunity cost

Question 2

Interest rate = risk-free + inflation + default + liquidity + maturity

Answer 2

▪️ Default: the possibility that the borrower will fail to make a promise.

▪️ Maturity: the increased sensitivity of the market value if debt to a change in market interest rates as maturity is extended.

Question 3

Nominal Risk-free Rate

Answer 3

= Real risk-free rate + inflation

Question 4

Future value of a single cash flow

Answer 4

FV = PV (1 + r)

Question 5

Non-Annual compounding

Answer 5

FV = PV [(1 + r/m)] ^ mN

Question 6

Continuous Compounding

Answer 6

FV = PV e ^ (rn)

e = 2.71

Question 7

Stated and Effective Rate

Answer 7

EAR = [(1 + periodic r)^m] - 1

Question 8

Ordinary annuity & Annuity due

Answer 8

▪️ Ordinary annuity: has a first cash flow that occurs one period from now.

▪️ Annuity due: has a first cash flow occurs immediately (at t = 0)

Question 9

Equal Cash flow (ordinary annuity)

Answer 9

FV = A [((1+r)^n) -1] / r

Question 10

PV of equal cash flow

Answer 10

PV = A [1 - (1/((1+r)^n) / r ]

Question 11

Present value of a perpetuity

Answer 11

PV = A / r