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Finance Chapter 5 vocab
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Terms in this set (16)
The 3 Basic Patterns of Cash Flows
Single amount-
A lump sum amount either held currently or expected in future
Annuity-
A level periodic stream of cash flow
(ex: Mortgage= constant, finite, not random)
Mixed stream-
A stream of unequal periodic cash flows (random growths/ "shrinks")
Future Value
•value of current deposit at a given future date and earning interest @ specific rate
•apply compound interest over pd of time
Compound Interest
•interest earned on a given deposit
•becomes part of the principal at end of period
•rate of change/ rate of return
Principal
•interest money paid
•"present value"
Present Value
•current dollar value of a future #
•investment today @ interest rate= future #
•dollar today> dollar tomorrow
Discounting the Cash Flows
•finding present values
•also know as:
-opportunity cost
-discount rate
-required return
-cost of capital
Annuity
•Stream of equal cash flow over pd of time
•can be inflows of return
•can be out flows of funds invested to be earned in future
Ordinary (deferred) Annuity
•deferred annuity
•cash flow @ end of each pd
Annuity Due
•cash flow @ start of each pd
•annuity due always > ordinary annuity b/c interest will compound for an additional pd
Perpetuity
•annuity w/ infinite cash flow
•continual annual cash flow
Compounding
• less than1 yr of compounding results in higher effective interest rate b/c earning interest on interest more frequently (ex: credit card)
•effective interest rate> nominal annual interest rate
•the more interest is compounded, the more the effective rate of interest will increase
•daily compounding= credit cards
monthly compounding= mortgages
Continuous Compounding
compounding interest an infinite number of times per year at intervals of microseconds
Nominal (stated) Annual Rate
the contracted annual interest rate charged by a lender or promised by a borrower
Effective (true) Annual Rate (EAR)
• the annual interest rate actually paid/ earned
•effective annual rate> nominal annual rate when compounding occurs more than once a year
Loan Amortization
•the periodic loan payments necessary to provide a lender with a specified interest return to repay the loan principal over a period of time
•The loan amortization process involves finding the future payments whose present value at the loan interest rate equals the amount of initial principal borrowed
Loan Amortization Schedule
•a schedule of equal payments to repay a loan
•shows the allocation of each loan payment to interest and principal
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