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FM > Unit 2 > Flashcards

Unit 2 Flashcards

1
Q

The goal of finance

A

Maximize the decider’s wealth

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2
Q

An investment is worth undertaking if it is expected that our wealth will increase as a result of the investment

A

True

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3
Q

To determine if an investment contributes to the increase of wealth, we compare which 2 figures?

A

The price of investment

The value of the investment

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4
Q

The price of the investment

A

The amount of money we need to pay upfront to undertake the investment

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5
Q

The value of the investment is …

A

the exact worth of the investment

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6
Q

Price

A

What you need to collect

What you actually paid for the investment

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7
Q

Value

A

What you think would be a fair price for the investment
What you think the investment is actually worth
The maximum amount of money an investor is willing to pay for an asset at a given moment in time

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8
Q

If we know the price and value of an investment, it will be easy to make the right decision

A

True

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9
Q

If price > value, the investment is:

a. good
b. bad

A

Bad because you pay more than you receive.

You lose money.

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10
Q

If price = value, the investment is:

a. good
b. bad
c. the same

A

C. The same

You pay the same amount that you receive.

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11
Q

If price < value, the investment is:

a. good
b. bad
c. the same

A

A. Good

You receive more than you pay so you gain money.

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12
Q

We are looking for opportunities where we …

A

pay less than the value of the company.

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13
Q

We find out the price by …

A

looking at the market or asking the seller of the asset.

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14
Q

We find out the value by …

A

calculating the future cash flows.

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15
Q

The value of money …

A

changes over time.

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16
Q

15 euros now is worth __________ than 15 euros in the future.

A

more

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17
Q

Why does the value of money change over time?

A
  1. Opportunity cost

2. Risk

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18
Q

What is opportunity cost?

A

To receive money in the future is to lose an opportunity to buy/invest and increase your wealth now

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19
Q

If you receive 1000 euros today, you can deposit it in the bank at an interest rate of 1% and get back 1,010 euros in a year. But, if you receive that same 1000 euros in a year, you will receive ______ euros.

Therefore, you have _______ the opportunity of ______ 10 euros.

This is an example of __________.

A

If you receive 1000 euros today, you can deposit it in the bank at an interest rate of 1% and get back 1,010 euros in a year. But, if you receive that same 1000 euros in a year, you will receive 1000 euros.

Therefore, you have lost the opportunity of gaining 10 euros.

This is an example of opportunity cost .

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20
Q

In finance, people are seen as _________

A

risk averse

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21
Q

Risk averse means

A

that you prefer certain outcomes to uncertain outcomes.

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22
Q

Since people are risk-averse, even if the opportunity cost is 0, it would be preferable to ___________ instead of ________ because ________.

A

get the money right now
in the future
if you get the money now, you have money, but if you get the money in the future, you only have the promise of money and the risk of that promise being broken.

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23
Q

What risks justify the time value of money?

A
  1. Solvency
  2. Inflation
  3. Interest
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24
Q

What is solvency risk?

A

When the person who must make the payment can’t pay because they don’t have any money

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25
Q

What is inflation risk?

A

When you can buy less things now with the same amount of money as before because the price of goods and services went up.

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26
Q

What is interest risk?

A

When you have undertaken an investment and you find another investment that would have been better to undertake, but you can’t undertake the second investment because you have already undertaken the first

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27
Q

Since the value of money changes overtime, any value we estimate must be associated with a specific amount

A

True

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28
Q

Capital

A

the sum of money in a given moment in time

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29
Q

Ct

A

the moment at which a sum is collected/paid

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30
Q

Timeline

A

the tool used to identify the timing of a capital

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31
Q

Future value

A

how much a sum of money is worth in the future

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32
Q

Ct > C0 means that the value of money …

A

increases with time through accumulation

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33
Q

You can’t simply add, subtract or multiply capital because ….

A

the time value of money is always there.

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34
Q

I(t) is

A

the interest in $$$$

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35
Q

I(t) =

A

Ct - C0

future value - present value

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36
Q

Accumulating means

A

calculating the future value of a given capital

move from beginning to end

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37
Q

Value in the future > value today means that we have

A

inflation

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38
Q

Present value of capital

A

the current value of a future sum

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39
Q

Discounting

A

calculating the present value of a given capital

move from end to the beginning

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40
Q

i

A

rate of interest

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41
Q

i =

A 
i = I1/C0
i = interest generated/initial capital
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42
Q

i =

A

i = (C1 - C0)/C0

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43
Q

d

A

rate of discount

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44
Q

d =

A 
d = I1/C1
d = interest generated/final capital
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45
Q

d =

A

d = (C1 - C0)/C1

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46
Q

Simple interest

A

C0*i

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47
Q 
C0 = 1000 euros
i = 2%
t = 3 yrs

The simple interest after 3 years is ______
The final value of the capital after 3 years is _________

A

C0 * i * t = I

C3 = C0 + I

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48
Q

Compound Interest

A

The interests at the end of each month are added to the capital and the interest is calculated on the new capital

49
Q 
I = 20 euros 
C0 = 1000 compounded yearly
t = 3 yrs

C1 = C3 =

A 
C1 = I+C0
C3 = (C1 * i) + C1 + (C2*i)
C3 = C2 + I3
50
Q

Ct (compounded) =

A

Ct = C0(1+i)^t

51
Q

Ct (simple interest) =

A

Ct = C0(1+it)

52
Q

Simple interest produces higher values when t < 1

A

True

53
Q

Compound interest produces higher values when t > 1

A

True

54
Q

Simple and compound interest produce different values if t = 1

A

False

The produce the same values at t = 1

55
Q

Compound interest is used for short term operations because it produces more money if t < 1

A

False

This is simple interest

56
Q

Compound interest is used for long-term operations because it produces more money if t > 1

A

True

57
Q

i(k)

A

the interest rate in period k

58
Q

i

A

the annual interest rate

59
Q

i(2)

A

the 1/2 yearly rate

60
Q

i(3)

A

the cuatrimestral rate

61
Q

i(4)

A

the quarterly rate

62
Q

i(12)

A

the monthly rate

63
Q

i(360)

A

the daily rate

64
Q

i(365)

A

the daily rate

65
Q

i(1/2)

A

the two year rate

66
Q

i(1/3)

A

the 3 year rate

67
Q

i(1/4)

A

the 4 year rate

68
Q

Convert the annual rate to the monthly rate (i -> i(12))

A

i/12 = monthly rate

69
Q

i -> 1(360)

A

1/360 = daily rate

70
Q

When estimating the value of capital …

A

the time and interest must be compatible (in same units)

71
Q

What do you do if the time and interest rates are not in the same units?

A
  1. Convert the units of time to match the rate

2. Convert the units for the rate to match the time

72
Q

Two rates are equivalent if …

A

for the same initial investment and period of time, the final value is the same for both interest rates

C1 @ i(k) = C2 @ i(t) = Cn

73
Q

d is the _______ discount

A

commercial

74
Q

With commercial discounts, C0 =

A

C0 = Ct(1-dt)

75
Q

A bill of exchange is

A

Like a cheque, but the bank writes it; the person with the paper collects the money from the bank, and if the bank has the paper, the bank collects from the person who wrote the cheque

76
Q

The value on a BOE is the face value

A

true

77
Q

Discount rate is the commercial discount rate

A

true

78
Q

A discount at a certain interest rate is just called a discount

A

true

79
Q

i = i(k)*k

A

true

80
Q

non-annual rate = annual rate/period of time

A

true

81
Q

discounting with a simple interest rate is the reverse of accumulating with simple interest

A

true

82
Q

In many short-term financial operations, the ______ capital is not calculated using a __________ but a _________.

A

initial
simple interest rate
simple discount rate

83
Q

Pressing F4 on the keyboard results in B5 transforming to ….

A

$B$5

84
Q

The difference between an interest rate and a discount rate is ….

A

the interest rate is applied to the initial capital

discount rate is applied to the final capital

85
Q

d = (C1-C0)/C1

A

true

86
Q

Discounting is applied to BOEs, Treasury Bills, IOUs, loans, invoice cash, etc …

A

true

87
Q

A bill of exchange is written as an unconditional order of payment of a sum of money at a fixed or determined period of time in the future

A

true

88
Q

The person who writes the BOE is called the drawer

A

true

89
Q

The person is who ordered to pay is called the drawer

A

false

the person ordered to pay is called the drawee

90
Q

If a drawer of a BOE does not want to wait until the due date of the bill, he may …

A

sell his bill to a bank at a certain rate of discount

91
Q

If the bank buys a BOE, they are now …

A

the holder AND owner of the bill

92
Q

After getting the bill, the bank will …

A

pay cash to the payee equal to the face value of the bill minus the interest or discount rate for the remaining time left on the bill

93
Q

The cost of discounting is also known as …

A

the interest paid by the drawer

94
Q

Given that the discount rate is applied to the final capital and the interest rate is applied to the initial capital, for a same rate, the discount is more expensive than the interest.

A

True

95
Q

We can calculate the rate of interest that is equivalent to a given discount rate. To so, we calculate the interests of a period.

A

True

Interest rate: I = C0i
Discount Rate: I = C1d
In both cases I = C1 - C0

96
Q

Interest rate: I = C0i
Discount Rate: I = C1d
In both cases I = C1 - C0

A

True

97
Q

d = i/1 + i*t

A

True

98
Q

i = d/1 - d*t

A

True

99
Q

In the compound interest method, the non-paid interests are periodically added to the initial capital (also called the principal) to generate future interests.

A

True

100
Q

In the compound interest method, the sum of the initial capital (or principal) and the interests generated to the date is called compound amount or accumulated value,

A

True

101
Q

In the compound interest method, the time between two successive interest computations is the interest period, compound period or conversion period.

A

True

102
Q

If we start from an initial capital of C0 and an interest rate of i per annum compounded annually, we can compute the value of that initial capital at any moment t as: Ct = C0(1+i)^t

A

True

103
Q

If we know the final capital and we want to calculate the initial capital, we can isolate C0.

A

True

C0 = Ct/(1+i)^t

104
Q

The interests generated between the moment 0 and the moment t would be C1 - C0

A

True

105
Q

I = C0[(1+i)^t -1]

A

True

106
Q

If you know the initial and the final capitals, as well as the time between them, you can find the interest rate with the following formula:

A

Ct=C0·(1+i)^t

107
Q

If you know the initial and the final capitals, as well as the interest rate, the time between the two capitals can be estimated with the following formula:

A

t=Ln(Ct/C0)/Ln(1+i)

108
Q

Like with simple interest, we can consider that two compound interest rates referred to different periods are equivalent if, for the same initial investment and over the same time interval, the final value of the investment, calculated with the two interest rates, is equal.

A

True

109
Q

We can calculate the annual rate i equivalent to a period rate ik.

A

True

ik = (1+i)^1/k - 1

110
Q

i = (1+ik)^k -1

A

True

111
Q

“Effective rates” are called so because they are directly applied to the initial capital to calculate the generated interests.

A

True

112
Q

It is common for financial contracts present a “nominal annual rate compounded on a given frequency” rather than the effective rate.

A

True

113
Q

Nominal annual rates are denoted as jk, k being the number of times that rate compounds per year.

A

True

114
Q

The equivalence between a nominal and an effective rate is the following: jk = ik *k

A

True

115
Q

The APR is an indicator of the effective cost or output of a financial operation.

A

True

116
Q

The APR includes …

A

all expenses and commissions of the financial operation.

117
Q

The APR is very useful to compare financial products

A

True

118
Q

Financial institutions are obligated to report the APR in the advertising of their financial products.

A

True

FM (11 decks)

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