lecture 3: annuities, perpetuities, EARS, and Inflation

Question 1

definition of annuity

Answer 1

a series of constant cash flows that occurs at the end of each period for some fixed number of periods.

• the amount of cash flow is constant
• interest rate is known
• time period of saving/borrowing is known

Question 2

definition of annuity due

Answer 2

an annuity for which the CFs occur at the beginning of the period

Question 3

definition of perpetuities

Answer 3

an annuity in which the cash flows last forever

• useful for forecasting value of long-term investments

Question 4

annual equivalent rate (AER) or Effective Annual Rate (EAR)..required to be quoted on–?

Answer 4

required to be quoted on all saving products in the UK

Question 5

Annual Percentage Rate (APR) or Effective Annual Percentage (EAP)…required to be quoted on–?

Answer 5

required to be quoted on all borrowing products in the UK

Question 6

what does APR or EAP cover?

Answer 6

• frequency of compounding
• any fees included in financing (financing costs)
  (IF there is no fees included in financing, APR is calculate the same way as EAR)

Question 7

what is core inflation?

Answer 7

inflation excluding the impact of foods and energy prices

Question 8

definition of nominal interest rate

Answer 8

interest rate excluding the impact of inflation

Question 9

definition of real interest rate

Answer 9

Interest rate after adjusted for the effect of inflation

Question 10

can nominal interest rate be negative?

Answer 10

yes

Question 11

does inflation affect PV(Present Value) calculations?

Answer 11

No