Topic 4 - Time Value Money And DCF Flashcards
What is the time value of money?
The principle that money today is worth more than the same amount in the future due to its potential earning capacity.
What is present value?
The current worth of a future sum of money given a specific rate of return.
What is future value?
The value of a current asset at a future date based on an assumed rate of growth.
What is compounding?
The process of earning interest on both the initial principal and the accumulated interest from previous periods.
What is discounting?
The process of determining the present value of a future amount by applying a discount rate.
What is a discount rate?
The interest rate used to calculate the present value of future cash flows.
What is an annuity?
A series of equal payments made at regular intervals over a period of time.
What is a perpetuity?
A series of equal payments made at regular intervals that continue indefinitely.
What is the formula for the present value of a perpetuity?
PV = C / r, where C is the cash flow per period and r is the discount rate.
Example sentence: If the cash flow per period is $100 and the discount rate is 5%, the present value would be $2,000.
What is the formula for future value with compounding interest?
FV = PV * (1 + r)^n, where PV is the present value, r is the interest rate, and n is the number of periods.
Example sentence: If the present value is $1,000, the interest rate is 3%, and there are 5 periods, the future value would be $1,159.27.
What is the formula for present value with discounting?
PV = FV / (1 + r)^n, where FV is the future value, r is the interest rate, and n is the number of periods.
Example sentence: If the future value is $5,000, the interest rate is 4%, and there are 3 periods, the present value would be $4,310.34.
What is the difference between simple interest and compound interest?
Simple interest is calculated only on the principal, while compound interest is calculated on the principal and previously earned interest.
What is an ordinary annuity?
An annuity where payments are made at the end of each period.
What is an annuity due?
An annuity where payments are made at the beginning of each period.
What is the formula for the future value of an annuity?
FV = C * [(1 + r)^n - 1] / r, where C is the payment per period, r is the interest rate, and n is the number of periods.
Example sentence: If the payment per period is $200, the interest rate is 6%, and there are 4 periods, the future value would be $902.36.
What is the formula for the present value of an annuity?
PV = C * [1 - (1 + r)^-n] / r, where C is the payment per period, r is the interest rate, and n is the number of periods.
Example sentence: If the payment per period is $150, the interest rate is 4%, and there are 6 periods, the present value would be $774.83.
What is the difference between nominal and real interest rates?
Nominal interest rates do not account for inflation, while real interest rates are adjusted for inflation.
What is the effective annual rate (EAR)?
The annual rate of interest that accounts for compounding within the year.
What is the formula for the effective annual rate (EAR)?
EAR = (1 + r/n)^n - 1, where r is the nominal interest rate and n is the number of compounding periods per year.
Example sentence: If the nominal interest rate is 8% and there are 4 compounding periods per year, the effective annual rate would be 8.39%.
What is the present value of a lump sum?
The value today of a single future payment, discounted at the appropriate rate.