ChFC - HS300, Chap 07

13 terms

Ungrouped Cash Flow

Payments are not the same and therefore must be compounded or discounted separately. One example is that of college tuition payments that increase from one year to the next.

Grouped Cash Flow

Consecutive payments are the same. A shortcut can be used to calculate aggregate compounding or discounting in this case.

Fisher Effect Equation

Accounts for inflation so as to produce the "real rate" of interest that you desire your invest to increase by.

Nominal Rate of Return = ((1 + real rate) * (1 + inflation)) - 1

Net Present Value (NPV)

The present value of the stream of cash inflows minus the present value of the stream of cash outflows.

Internal Rate of Return (IRR)

The interest rate at which returns equal costs.
(The discount rate at which the present value of the stream of cash inflows equals the present value of the stream of cash outflows.)

Conversion of Interest Earnings into Principal

When using compounding interest (as opposed to simple interest), the interest from previous periods become part of the principal for the purposes of calculating interest during the current period.

Continuous Compounding

Interest is compounded an infinite number of times per period.

Effective Annual Interest Rate (EAR)

The annual interest rate which is equivalent to the nominal rate with the actual frequency of compounding.

For instance, a nominal rate of 9% with quarterly compounding leads to an EAR of 9.3%.

Annual Percentage Rate

The periodic rate (PER), which can be monthy, daily, etc., multiplied by the number of periods (f) in a year (12, 365, etc.).

APR = PER * f

Formula for EAR using APR

For monthly payments: EAR = (1 + APR/12)^12 - 1

Formula for Periodic Rate (PER) using EAR

PER = ((1 + EAR)^(1/f)) - 1

Simple Annuity [Due]

An annuity in which the frequency of payments and the frequency of compounding (or discounting) are identical.

Complex Annuity [Due]

An annuity in which the frequency of payments and the frequency of compounding (or discounting) are different.