Time Value of Money Flashcards
The return that investors and savers require to get them to willingly lend their funds
Required Rates of Return
A theoretical rate on a single-period loan that has no expectation of inflation on it
Real Risk Free Rate
Real Risk Free Rate + Expected Inflation Rate + Default Risk Premium + Liquidity Premium + Maturity Risk Premium
Nominal Risk Free Rate
The risk that a borrower will not make the promised payments in a timely manner
Default Risk
The risk for receiving less than fair value for an investment if it must be sold for cash quickly
Liquidity Risk
Long term bonds are more volatile than Short term bonds. Therefore, Long term bonds have more maturity risk, so there are premiums to compensate investors
Maturity Risks
Actual annual rate of return, being earned after adjustments have been made for the different compounding periods
Effective Annual Rate (EAR)
Effective Annual Rate Calculation
EAR == (1+r)^m -1
r = periodic rate == (stated annual rate)/ m m= number of compounding periods per year
Continuous Compounding Effective Annual rate
e^r -1
Future Value Formula for Different compounding frequencies
PMT(1+(r/m))^n = FV
PMT = Payment r = periodic rate m = number of compounding periods per year n = number of years FV = Future Value
The amount to which a current deposit will grow over time when it is placed in an account paying compound interest.
Future Value
Future Value for a Single Sum
FV = PV(1+(I/Y))^n
FV = Future Value PV = Present Value I/Y = Rate of Return per Compounding Period N = Number of Compounding Periods
Future Value Interest Factor
(1+(I/Y))^N
Cash flows that occur at the end of each compounding period
Ordinary Annuity
Payments/Receipts occurring at the beginning of each period
Annuity Due
* There is one more compounding period in an Annuity Due instead of the ordinary annuity
