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Finance Exam 2
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Gravity
Key Concepts:
Terms in this set (17)
Time Value of Money
the principle that a dollar received today is worth more than a dollar received in the future
Difference between Compounding and Discounting
Compounding: The process of accumulating interest on an investment over time to earn more interest. Used to know future value of money
Discounting: Way to find present value of future money
What happens to the size of a cash flow if you were to discount it additional periods?
As the number of discounting periods between now and the cash arrival increases, the present value decreases. As the discount rate (interest rate) in the "present value" calculations increases, the present value decreases.
Present Value Factor
1/(1+r)^t
Future Value Factor
(1+r)^t
The Rule of 72
The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest. Years to double = 72 / Interest Rate
Nominal Interest Rate
the interest rate as usually reported without a correction for the effects of inflation
Difference between APR and EAR
APR - The interest rate charged per period multiplied by the number of periods per year.
EAR - The interest rate expressed as if it were compounded once per year. Equation: (1 + i/n)n - 1
annuity
A level stream of cash flows for a fixed period of time
Ordinary Annuity
Annuity for which the cash flow occur at the END of the period
Annuity Due
an annuity for which the cash flows occur at the BEGINNING of the period; Annuity due always normally higher.
Perpetuity
PVA (infinity) = C/r
What happens to the present value of an annuity if the discount rate decreases?
An increase in the discount rate decreases the present value factor and the present value.
Pure Discount Loan
the borrower receives money today and repays a single lump sum at some time in the future
Interest-only loan
A loan that only requires the payment of interest for a stated period of time with the principal due at the end of the term.
Amortized Loans
a loan paid off in equal installments
Amortization Schedule
provides a summary of the cash interest payments, interest expense, and changes in carrying value for debt instruments
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