L1 - Introduction and Time Value of Money

Question 1

What are 2 things the interest rate is called?

Answer 1

• Price of money
• Opportunity cost of money

Question 2

What is the most accurate measure of interest rate?

Answer 2

Yield-to-maturity

Question 3

What is the Present Value (PV) of money?

Answer 3

The point of time today

Question 4

What is the Future Value (FV) of money?

Answer 4

A point of time in the future

Question 5

What are the 2 types of interest?

Answer 5

• Simple Interest
• Compound Interest

Question 6

What is simple interest?

Answer 6

Interest (paid) earned on only the original amount, principal, borrowed (lent)

Question 7

What is the FV formula for simple interest?

Answer 7

FV = PV x (1 + r x n)

Question 8

What is compound interest?

Answer 8

Interest paid (earned) on any previous interest earned, as well as on the principal borrowed (lent)

Question 9

What is the FV formula for compound interest?

Answer 9

FV = PV (1 + r)^n

Question 10

What can we think of (1 + r) as?

Answer 10

A Growth Factor

Question 11

What is the formula for calculating the PV of a sum of money available in the future?

Answer 11

PV = FV / (1+r)^n

Question 12

What is computing the present value called?

Answer 12

Discounting

Question 13

What is Discounting the opposite of?

Answer 13

Interest Compounding

Question 14

What does the frequency of compounding affect?

Answer 14

The FV and PV of cash flows

Question 15

What can the stated interest rate deviate significantly from?

Answer 15

The true interest rate

Question 16

If we compound quarterly, what will the rate and number of compounding periods be?

Answer 16

• Rate = r/4
• 4n compounding periods in n years

Question 17

Typically, what are the interest rates of any given financial operation presented on?

Answer 17

Nominal annual basis

Question 18

What does the Effective Rate of the financial operation depend on?

Answer 18

The periodicity of the payment of interest

Question 19

For compounding with m periods (equally spaced payments over the year), what does the account grow by a factor of?

Answer 19

(1 + r/m)^m

Question 20

What is the formula for the effective interest rate?

Answer 20

re = (1 + rn/m)^m - 1, where n = nominal

Question 21

What is the FV formula?

Answer 21

FV = PVe^rn

Question 22

What is the PV formula?

Answer 22

PV = FVe^-rn

Question 23

What is an annuity?

Answer 23

A constant cash flow that occurs at regular intervals for a fixed period of time

Question 24

What are 2 types of annuity?

Answer 24

• Ordinary annuity
• Annuity due

Question 25

How can the PV of an annuity be calculated?

Answer 25

- By taking each cash flow and discounting it back to the present. - PV = C/(1+r) + C/(1+r)^2 + C/(1+r)^3 + ... n terms - C / (1+r)^i

Question 26

What is the short cut formula for an Ordinary Annuity calculation?

Answer 26

PV = (CF/r)[1 - 1/(1+r)^n] - CF = annuity; - r = discount rate

Question 27

What is Annuity-due?

Answer 27

An annuity for which payments are made at the beginning of payment periods - The first payment is made at time 0, and the last payment is made at time n -1

Question 28

What is the formula for the PV of an annuity due?

Answer 28

PV = (CF/r)[1 - 1/(1+r)^n] x (1+r)

Question 29

What is the alternative formula for the PV of an annuity due?

Answer 29

PV = CF + (CF/r)[1 - 1/(1+r)^(n-1)]

Question 30

What is a perpetuity?

Answer 30

An infinite sequence of constant periodic payments CF occurring at the end of each period

Question 31

How is the PV of a perpetuity calculated?

Answer 31

CF/r