Week 2 Flashcards
(20 cards)
What is perpetuities?
- When a constant cash flow will occur at regular intervals forever it is called a
perpetuity - The value of a perpetuity is simply the cash flow divided by the interest
rate.
Formula for present value of a perpetuity?
PV ( C in perpetuity) = c/r
What is annuities?
◦ When a constant cash flow will occur at regular intervals for a finite number of N periods, it is called an annuity.
What is the equation for Present Value of an Annuity?
PV (annuity of C for N periods)
= P - PV(P in period N)
= P( 1-(1/(1+r)^N))
Equation for future value of an annuity?
C x 1/r ((1+r)^N - 1)
What is growing perpetuity?
◦ Assume you expect the amount of your perpetual payment to increase at a constant rate, g
Equation for PV (Growing perpetuity)
C/(r-g)
Equation for growing perpetuity along a timeline?
C x (1+g)^ (no. of the year)
What is growing annuity?
◦ The present value of a growing annuity with the initial cash flow c, growth rate g, and interest rate r is defined as:
◦ Present Value of a Growing Annuity
Equation for growing annuity?
PV = C x (1/(r-g)) x (1-(1+g/(1+r))^N)
How is interest rate quoted ?
- Typically the interest rate is quoted as an annual rate, although interest
payments may occur at different intervals (compounding period)
What do we do when evaluating cash flow?
◦ When evaluating cash flows we need to ensure that the discount rate we use
matches the time period on which it is applied
Equation for Interest Rate Quotes and Adjustments?
𝑭𝑽=𝑷𝑽×〖(𝟏+𝒓/𝒎)〗^𝒕𝒎
What is the effective annual rate (EAR)?
is a convenient way to avoid referring to the compounding period. In essence, it shows the actual amount of interest that would be earned at the end of one year.
What is The Annual Percentage Rate/ Annual Equivalent Rate (APR/AER) ?
indicates the amount of interest
earned in one year without the effect of compounding. Hence, it cannot stand on its own unless we define the compounding period.
What are the determinants of interest rates?
- Central Bank Policies
- Inflation Expectations
- Supply and Demand for Credit
- Economic Growth
What is Nominal interest rate?
The rates quoted by financial
institutions and used for discounting or compounding cash flows
What is real interest rate?
The rate of growth of your purchasing
power, after adjusting for inflation
What is growth of Purchasing Power?
Growth of Money / Growth of Prices
Equation for Growth of Purchasing Power?
1 + Rr = ((1+ r)/(1+i))
