Time Value of Money

Question 1

Interest rates are also known as: (3)

Answer 1

• required rate of return
• discount rate
• opportunity cost

Question 2

Interest rate is the sum of:

Answer 2

= real risk-free interest rate + inflation premium + default risk premium + liquidity premium + maturity premium

Question 3

Nominal risk-free rate of return =

Answer 3

= real risk-free interest rate + inflation premium

aka the “risk-free rate”

Question 4

Continuous Compounding future value formula:

Answer 4

= FVn= PVe^rn

an investment worth. $50k earns interest that is compounded continuously. The stated annual interest is 3.6%. What is the FV of the investment after 3 years?

1. .036*3
2. 2nd button
3. e*
4. x $50k

Question 5

Effective annual rate for discrete compounding =

Answer 5

EAR = (1 + periodic interest rate) ^m - 1

periodic interest rate = stated annual rate / compounding period

Question 6

Effective annual rate for continuous compounding =

Answer 6

EAR = e^rs - 1

12% stated annual rate and continuous compounding, EAR =
on cal
1. .12
2.  e*
3. -1
=

Question 7

Annuity Due

Answer 7

• the first payment is received at the start of the first period

Question 8

Calculator keystrokes to put the calculator in “Annuity Due” mode:

Answer 8

• 2nd, BGN, 2nd, SET
• 2nd, QUIT
• 2nd, CLR TVM
• n
• i/y
• etc
• CPT whatever you’re solving for
• 2nd, BGN, 2nd, SET
• 2nd, QUIT

Question 9

PV of a perpetuity formula

Answer 9

= PV = annuity payment amount / discount rate

PV = A / r

Question 10

An annuity or perpetuity beginning sometime in the future can be expressed in present value terms …

Answer 10

• ONE PERIOD PRIOR TO THE FIRST PAYMENT. THAT VALUE CAN THEN BE DISCOUNTED BACK TO TODAY’S PV
  ex: You are offered a cash flow of $10 at the end of each year forever starting in year 5. What is the PV of these CFs, assuming a discount rate of 10%?
• PV of perpetuity at the end of year 4:
  PV4= $10 / .1 = $100
• $100 has to be discounted back to time 0:
  PV0 = $100 / 1.1^4 = $68.30