Time value of money

Question 1

Different ways to interpret interest rates

Answer 1

Discount rates, opportunity cost, rates of return

Question 2

Components of interest rate

Answer 2

Real risk free interest rate
\+ inflation premium [= nominal risk free interest rate]
\+ default risk premium
\+ liquidity premium 
\+ maturity premium
= Interest rate

Question 3

Effective annual rate

Answer 3

EAR = [(1 + periodic interest rate)^m] - 1
EAR = (e^r) - 1 [continuous]

Question 4

Time value of money - different compounding periods

Answer 4

More compounding, more interest, more growth

Question 5

FV/PV single sum

Answer 5

Use FV/PV

Question 6

FV/PV ordinary annuity

Answer 6

Use FV/PV

Question 7

FV/PV annuity due

Answer 7

Annuity with immediate payment due. Do FV/PV for rest of annuity and add immediate payment.

Question 8

PF perpetuity

Answer 8

PV = A/r

Question 9

FV/PV unequal cash flows

Answer 9

Always able to do FV/PV of individual cash flows (cash flow additivity)

Question 10

Discount rate

Answer 10

Rate at which future sum discounted for passage of time

Question 11

Maturity premium

Answer 11

Compensation for investor for increased sensitivity of value of debt to change in interest rates as maturity extended

Question 12

Continuous compounding FV

Answer 12

FV = PV * e ^rN