Week 1 Flashcards
What is an annuity?
series of cash flows for the same amount each period for a period of time (start and stop)
What is a growing annuity?
Series of equal cash flows that occur after an interval of time, they grow at a constant rate
Also called an increasing annuity
Formula for Annuity
PV = cashflow * ((1-(1/(1+r)^t)/r)
PV formula
PV = Cashflow /(1+r)^t
Or
PV = FV/(1+r)
Steps of TVM
Step 1: Convert to an effective rate
Step 2: effective rate and cash frequency must match
APR VS EAR
APR: No compounding
EAR: Compounding
How to get EAR from APR?
EAR = APR / n (n = 2 for semi annual, n = 12 for monthly)
What is cost-push inflation?
cost of businesses rise and it’s past onto customer (raw material prices rise) extra costs goes to customers
What is demand inflation?
demand too high, they cannot keep up the supply so they charge more
What happens when governments print money?
stimulate the economy to create more jobs, print more money, increase the number of notes or increase government debt. As the amount of money increases, the value starts to fall.
What is inflation?
general rise in price levels
What are three key drivers for the difference in value between the money you have today and the money you expect to receive in the future?
Inflation
Payments in future are not guaranteed
Lost opportunity
What is default risk?
The risk that future payment will not be received
What is interest rate?
rate to use to equate money received in the future (FV) with the money you have now (PV)
Formula for FV
Future Value = Present Value + Interest
FV = PV + PV(r)
FV = PV(1+r)
What is discount rate?
captures all three drivers of the difference between PV and FV, higher expected inflation, greater likelihood of default or higher opportunity costs, will increase the discount rate
Two things every annuity has
Payment amount (c) Number of times the payment is made (t)
What is the growth rate?
rate of growth between each payment in an annuity (assumes first payment is received one period from the present)
Formula for growing annuity
PV = (C/(r0g))*(1-((1+g^t)/(1+r)^t))
What is perpetuity?
series of repetitive cash flows that never end (once it begins, it never ends)
Formula for perpetuity
PV = CF / r
Formula for growing perpetuity
PC = CF / (r-g)
How are APR rates determined?
multiplying actual (effective) interest rate by the number of compounding periods in year
