Finance Chapter 6

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What is the formula to convert from the quoted rate to the EAR

(1+ r/n)^n=(1+j)^n --> j formula

What must you multiply an annuity by to make it an annuity due? Why?

(1+r) where r is the discount rate This is because there is an extra payment at t=0 for annuities due (the payment at the beginning of the month)

If calculating the PV of an annuity, what is the FV of an annuity?

0 - leave blank on calculator

What are the two ways to calculate future values for multiple cash flows

1) compound the accumulated balance forward one year at a time 2) calculate the future value of each cash flow and add them up

Hoffstein corporation is about to pay a dividend of $3/share. Investors anticipate that the annual dividend will rise by 6%/year forever. r=11. What is the price of the stock today?

3 * 1.06 = 3.18 PV = 3 + 3.18/(.11-.06) = $66.6 The formula will only calculate the PV for all dividends beginning a year from now. For true PV must add this year's dividend on to the PV

What is a balloon payment?

A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity. The final payment is called a balloon payment because of its large size

What is an annuity?

A level stream of cash flows for a fixed period of time (payments are the same each month)

What is an annuity due?

An annuity paid at the beginning of the period

What is a perpetuity?

An annuity with no forseeable end date

What is the assumed timing of annuity payments?

At the end of the period

What is the underlying timing assumption for growing perpetuities

Cash flows are received and disbursed at discrete regularly spaced intervals

What is the formula to calculate the EAR with continuous compounding

EAR = (e^quoted rate) -1

What is the EAR

Effective annual rate - the interest rate expressed as if it were compounded only once per year

What is the formula for the PV of a growing annuity?

PV = (C/(r-g))[1-((1+g)/(1+r))^t]

What is the formula for a growing perpetuity

PV = cash flow/(r-growth rate)

What is the formula to calculate a perpetuity

PV*r = cash flow

What is the formula to calculate a perpetuity

PV*r = cash flow or PV = Cash flow/r

What do you have to do for an annuity due?

Set your calculator to calculate payments at the beginning of the period

What is an interest only loan?

The borrower pays the interest payments monthly and repays the original loan amount in the future

What does the numerator signify for a growing perpetutity

The cash flow is the cash flow ONE PERIOD FROM NOW. In a question if you are given 'the company is about to pay a dividend of $3 and expect it to grown 6%/year forever' the cash flow will be 3*1.06 = 3.18

What is an amortized loan?

The lender requires the borrower to repay the loan over time. The repayment of the principle remains the same with a smaller and smaller percentage going toward the interest payments as the principle decreases

What is the PV of future cash flows?

The money you would need today to pay out the future cash flows indicated

What is a growing annuity?

a finite number of growing cash flows

what is an example of a perpetuity?

a fixed rate stock

what is an example of an annuity due?

a least payment --> e.g. rent is due at the begining of the month

What is a perpetutity

an annuity with indefinite cash flows

what is an APR

annual percentage rate - the monthly rate or semiannual rate multiplied by the number of periods. It is not the effective annual rate

What is the compounding period for a mortgage by law?

semi annual

What is a pure discount loan?

the borrower repays the loan in one lump sum payment

what is the quoted interest rate?

the interest rate expressed in terms of the interest payment made each month


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