Topic 1 - Financial Decision Making Flashcards
Present Value Formula
PV = Future Savings / (1 + r)^n
Future Value Formula
FV = Present Savings x (1 + r)^n
Net Present Value Formula
NPV = PV (benefits) - PV (costs)
- ALWAYS use NPV to compare 2 projects/ investments
The Law of One Price
States that in an efficient market, identical goods should sell for the same price regardless of where they are sold.
Arbitrage Opportunity
A trading strategy that yields profit without taking risk or making any investment. Once people recognize an arbitrage opportunity the price quickly rises.
(EG. money lying on the street, once spotted disappears quickly)
Effective Annual rate formula (EAR)
EAR = ( 1 + i/n )^n - 1
EAR definition
Effective Annual Rate is used to calculate the actual return on an investment or loan when interest is compounded more frequently that annually.
Separation Principle
we can separate a firms investment decisions from its financing choice.
Term Structure
The relationship between the investment term and the interest rate is called the term structure of interest rates.
It is determined in the market based on the individuals willingness to borrow and lend.
Annuity Definition
A special stream of cash flows that pays the same amount regularly for an finite number of periods
Perpetuity Definition
A special stream of cash flows that pays the same amount regularly for an infinite number of periods
Present Value of an annuity
PV = C/r - C/r(1+ r)^N
Present value of a perpetuity
PV = C/r
Time Value of Money
The difference in value between money today and money in the future.
Risk free interest rate
The rate at which money can be borrowed or lent without risk
The 3 Rules of Time Travel
- Only possible to compare or combine values at the same point in time
- To move CF forward we must compound it
- To move CF backward we must discount it
APR
Annual Percentage Rate, is the amount of simple interest earned in one year, without considering the effects of compounding interest
Mutually Exclusive
when 2 projects can’t happen simultaneously
Factors that influence willingness to borrow and lend
- Inflation
- Government Policy
- Expectations of future growth/ future interest rate changes
PV growing perpetuity formula
PV = C/r-g
