Topic 2: Time Value of Money

Question 1

Competitive Markets

Answer 1

A market which goods can be bought and sold at the same price.

Question 2

Valuation Principle

Answer 2

States that:

1. Value of assets determined by competitive market price.
2. CBA done with market price.
3. When B>C, decision will increase value of firm.

Question 3

Law of One Price

Answer 3

In Competitive Markets, securities with same CF must have same price.

Question 4

Arbitrage

Answer 4

Practice of buying and selling same goods to take advantage of price differences.

Question 5

Interest Rate

Answer 5

Rate of which money can be borrowed or lent over a given period.

Question 6

Net Present Value

Answer 6

Value calculated in terms of dollars today.

Question 7

Discount Factor

Answer 7

Value today of a dollar received in the future.

Question 8

Discount Rate

Answer 8

Rate to discount cash flows to determine value at an earlier time.

Question 9

Rules to Value CF

Answer 9

1. Compared values must be at the same point in time.
2. To calculate a CF’s FV, we must compound it.
3. To calculate a CF’s PV, we must discount it.

Question 10

Compound Interest

Answer 10

Interest earned on previously earned interest.

Question 11

Simple Interest

Answer 11

Interest earned on initial deposits only.

Question 12

Rule of 72.

Answer 12

Years to double ~= 72/(Interest Rates).