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CFA Learning > Time Value of Money > Flashcards

Time Value of Money Flashcards

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CFA flashcards
1
Q

What does FV20 = $200,000 mean?

A

The Future Value in Year 20 is $200,00

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2
Q

What does Present Value mean?

A

The value of some future value in the present

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3
Q

What is the discount rate?

A

The rate of growth.

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4
Q

What is the relationship between Present Value and Future Value?

A

Present value is always smaller than the future value.

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5
Q

What is the time value of money?

A

A method of valuing any cash flow in any time through compounding or discounting.

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6
Q

What is the real risk-free interest rate

A

A theoretical rate that an investor would receive with no risk.

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7
Q

What is an example of a risk-free interest rate?

A

U.S. Treasury Bill

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8
Q

Why are treasury bills considered to be risk free?

A

They are backed by the government and are liquid.

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9
Q

What is inflation premium?

A

Recognizes that investors must be compensated for decreased buying power due to inflation.

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10
Q

What is the real interest rate plus the inflation premium called?

A

Nominal risk-free rate.

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11
Q

What is default risk premium?

A

Compensates the investor for default risk, or not getting paid back.

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12
Q

What would increase the default risk premium?

A

A company takes on more debt and must pay a higher rate.

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13
Q

What is liquidity premium?

A

Extra compensation for the loss that would be incurred if the investor had to liquidate the security quickly.

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14
Q

What is maturity premium?

A

Extra compensation for the greater chance of change in the market interest rate, leading to a greater risk for longer maturity bonds.

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15
Q

If a debt instrument had to be sold at a lower price because there were few buyers for that particular instrument. What sort of risk is this?

A

Liquidity.

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16
Q

What would be an example of an increase in default risk?

A

A company issuing bonds with very high interest payments and low cash flows.

17
Q

What is the required rate of return?

A

The rate you need to earn on an investment in order for it to meet your reward expectations.

18
Q

What should the required rate of return be viewed as?

A

A floor when comparing investments.

19
Q

What does the discount rate measure?

A

the rate by which the value of a future cash flow is reduced so that you can think of it in terms of cash received today.

20
Q

What is Opportunity cost, in terms of interest rates?

A

the rate of return you are missing out on if you choose to forgo the equivalent cash flow.

21
Q

Do some banks value the ability to increase their assets overnight to meet regulations?

A

Yes.

22
Q

What is an equivalence relationship?

A

When two opportunities yield the same dollar amount over time.

23
Q

What is the formula for computing the future value of a sum of money today?

A

FVn = PV(1+r)^N

24
Q

What is compounding?

A

Interest earned upon previous interest paid.

25
Q

What are examples of Frequency of Compounding

A

Semiannual, quarterly, monthly, weekly, or even daily.

26
Q

What are annual rates referred to as?

A

Stated annual rates or quoted interest rate.

27
Q

What is the stated annual rate referred to if it is compounded other than annually?

A

It is referred to as the periodic rate

28
Q

How do you calculate the periodic rate?

A

r / m

r = stated annual rate.
m = number of compounding periods per year.
29
Q

When there is more than one compounding period per year, the future value formula is expressed as:

A

FVn = PV ( 1 + r/m) ^mN

30
Q

What are Annuities

A

Series of equal cash flows equally interspaced in time.

31
Q

When compounding is continuous, the equation for future value is

A

FVn = PVe^rT

32
Q

What is the Effective Annual Rate (EAR)

A

It is the annual interest rate compounded annually that is equivalent to a stated annual interest rate that is compounded other than annually.

33
Q

What is the equation for EAR?

A

EAR = ( 1 + Periodic Rate)^m - 1

34
Q

Equation for calculating the future value of an ordinary annuity:

A

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

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