Flashcards in Topic 2: Part 1 and 2 Deck (29):

1

## Time value of money

###
We typically prefer money immediately to money in the future

-risk, inflation, preference

Time value of money reflects opportunity cost

2

## Gross interest

### Gross interest is interest before taxes

3

## Net interest

### Net interest is interest after taxes

4

## Annual Percentage Rate (APR)

###
The annual percentage rate (APR) is the true annual interest rate which takes account of the timing of interest and principal payments.

•in context of banks, expressed as annual equivalent rate (AER)

5

## Simple interest

###
Simple interest is the interest computed only on the principal.

FVsi = P(1+n.i)

6

## Compound interest

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Compound interest is the Internet paid on the sum which accumulates, ie the principal plus interest.

FVci = P(1+i)^n

7

##
Compound interest

Non-Yearly

###
Interest is paid m times each year

Compound interest rate is i

FVci = P(1+i/m)^nm

8

## Calculate APR

### APR = (1+i/m)^m -1

9

## APR and Final Value

### FV = P(1+APR)^n

10

## Present Value

### The present value is the current worth of future cash flows

11

## Discounting

### Discounting is the process of reducing cash flows to present values

12

## Annuity

### An annuity is a constant annual cash flow for a prescribed amount of time

13

## Perpetuity

### A perpetuity is a constant annual cash flow for an infinite period of time

14

## Bonds

###
•we assume a fixed coupon rate

•we assume a yearly payment schedule (unless stated otherwise)

15

## Bonds: Discount

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The discount is the amount below the face value of a financial instrument at which it sells

•coupon rate less than market rate (interest)

16

## Bonds: Premium

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The premium is the amount above the face value of a financial instrument at which it sells

•coupon rate must be more than market rate (interest)

17

## Yield to Maturity

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The interest rate at which the present value of the future cash flows equals the current market price

Interest rate = coupon rate

18

## Yield curve

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•Yields are changing over time

•yields upward sloping at a given time

19

## Why is the yield curve upwards sloping?

###
Expectations theory

-investors believe interest rates to rise in the long run

Liquidity preference theory

-investors prefer to have cash on hand rather than invest

Market segmentation theory

-different agents active on market for short term and long term bonds

20

## Dividend

### A dividend is a distribution of a portion of a company's earnings or profits in the form of a sum of money paid (typically annually) to its shareholders.

21

## Difference between primary and secondary market

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Primary market: direct sale of securities to owners/creditors

Secondary market: securities traded between owners/creditors

22

##
Difference between auction and dealer market

###
Auction markets: market matches buyers and sellers

Dealer markets: buying and sleeping done by dealers

23

## Why do financial intermediaries exist?

### The need of lenders and borrowers rarely match perfectly, so financial intermediaries step in to alleviate this issue.

24

## Explain why money now is worth more than money in the future.

###
Risk: money today is certain.

Inflation: value of money declines over time.

Preference: we prefer immediate consumption.

25

## APR

### APR is the true annual interest rate which takes into account of the timing of interest and principal payments.

26

## What is the difference between an annuity and a perpetuity?

###
Annuity: a constant annual cash flow for a prescribed period of time.

Perpetuity: a constant annual cash flow for an infinite period of time.

27

## When do bonds trade at a discount and when at a premium?

###
Discount: coupon rate (bond interest) is less than market interest rate.

Premium: bond more attractive than putting money in the bank.

28

## 3 explanations why yield curve is upwards slopping

###
1. Expectations theory

Implies investors believe interest rates to rise in the long run.

2. Liquidity preference theory

Investors prefer to have cash on hand rather than invests.

3. Market segmentation theory

Different agents on market for short term and long term.

29