# WEEK 4 - Time Value of Money Flashcards

Why do we need to add a rate of return to assets?

As compensation for:

- Time
- Inflation
- Risk

How do we calculate Future Value?

FV = PV(1+R)n

What’s the difference between simple interest and compound interest?

Simple Interest is the interest on the initial investment

Compound interest is interest on interest (exponential growth)

(1+r)n - Compound Factor

How do we calculate Present Value?

PV = FV/(1+R)n

OR

PV = FV X 1/(1+R)n

where n is to the power of

Where the discount factor 1/(1+r)t < 1 denotes PV of £1 received in future

What is the calculation for the Future Value when we consider differing time period payments (i.e monthly, quartlerly etc.)

FV = PV (1+R/M)txm

txm is to the power of

Where:

R is annual interest

M number of compound periods per annum

t number of years

What is the calculation for FV and PV when we are looking at continuous compounding?

FV= PV e (txr)

Where t x r is to the power of

PV = FV e (-t x r)

Where - t x r is to the power of

What is the effective interest rate?

Actual annual interest rate paid on an investment or loan. It is used to compare the annual interest between investments, or loans with different compounding periods.

How do you calculate the effective interest rate?

(1+r/m)m - 1

Where m is to the power of

What is a simple annuity defined as?

Series of fixed payments of a fixed amount for specified number of periods

e.g. Bonds, regular savings, regular loan payments etc.

What is a Perpetuity defined as?

Where cash flows last indefinitely

e.g real estate

How do you calculate Perpetuity?

Present Value

PV = C/(1+R)1 + C/(1+R)2 ETC.

Formula given as:

PV = C/R

Where C is cashflow/coupon

How do you calculate the ordinary annuity? (Present Value)

PV = C/R (1- 1/(1+R)t)

Where t is to the power of

How do you calculate the Ordinary Annuity?

Future Value

FV = C/R x ((1+R)t - 1)

Where t is to the power of

What is Holding Period Return?

The rate of return that investors obtain over a specific period of time

How do you calculate the Holding Period Return?

r = (D1 +P1 - P0)/ P0

Where:

P0: Denotes value of investment at beginning of holding period

P1: Denotes value of investment at end of holding period

D1: Denotes dividend or interest payment received during that period