Time Value Of Money Chapter 5

Question 1

What is the difference between an ordinary annuity and an annuity due?

Answer 1

• If the payments occur at end of each year, the annuity is an ordinary (or deferred) annuity.
• If the payments are made at the beginning of each year, the annuity is an annuity due.

Question 2

Annuities must?

Answer 2

1 constant payment
2 specified # of periods
3 fixed intervals

Question 3

Nominal rate?

Answer 3

also called the annual percentage rate (APR) (or the quoted or stated rate). An annual rate that ignores compounding effects.
Ex: credit card loan, student loan, auto loan

Question 4

Periodic rate (IPER)?

Answer 4

amount of interest charged each period, e.g. monthly or quarterly.
▪ IPER = INOM/M, where M is the number of compounding periods per year.
Ex: 4 quarters for 12 months compounding = 3%

Question 5

Effective (or equivalent) annual rate (EAR =?

Answer 5

the annual rate of interest actually being earned, considering compounding.

Question 6

Why is it important to consider effective rates of return?

Answer 6

investments with different compounding intervals provide different effective returns to compare investments with diffrent compounding intervals you must look at effective returns ex; bank or car loans