quiz 1 intermediate finance
Amortization schedule; principal versus interest component of a payment; amortized loan
Amortization schedule- It is a table that shows the payment of each period on the amortized loan. It shows the payment of loan principal and interest over the period of time till the loan is repaid fully. Amortization schedule is used by borrowers and lenders.
Annual, semiannual, quarterly, monthly, and daily compounding
Annual compounding: Here the cash flow is compounded just once in a year. Eg below: FV = $1,000 x (1 + (20%/1)) ^ (1 x 1) = $1,200 Semiannual compounding: Here the cash flow is compounded twice a year. Eg below: FV = $1,000 x (1 + (20%/2)) ^ (2 x 1) = $1,210 Quarterly compounding: Here the cash flow is compounded four times a year. Eg below: FV = $1,000 x (1 + (20%/4)) ^ (4 x 1) = $1,215.5 Monthly compounding: Here the cash flow is compounded 12 times a year. Eg below: FV = $1,000 x (1 + (20%/12)) ^ (12 x 1) = $1,219.4 Daily compounding: Here the cash flow is compounded 365 times a year. Eg below: FV = $1,000 x (1 + (20%/365)) ^ (365 x 1) = $1,221.4
Compounding; discounting
Compounding: It is the process where the value of an asset or investment increases because the earnings on an asset or investment, both capital gains and interest, earn interest as time passes. Discounting: It is the process of determining the present value of a payment or periodic payments that are to be received in the future time line.
Opportunity cost rate
Opportunity cost rate: It is the interest rate of the opportunity cost ie it is the rate which would have been earned if we had chosen a certain investment but we decide to forego it and chose some other investment.
Outflow; inflow; time line; terminal value
Outflow: It means any flow of income/expense/cash flow out of the business or for incurring capital expenditure. Inflow: It means any flow of income/expense/cash flow into the business or for by selling of an asset. Timeline: Timeline refers to the time frame that could be needed to complete a transaction. Terminal value: Terminal value represents the future cash flows in an asset valuation which we will receive.
perpetuity (consol)
Perpetuity: Perpetuity refers to an state of lasting forever. In finance, it is a constant stream of identical cash flows forever. Consol: Consol are known as perpetual bonds with fixed stream of income with no maturity date. These are not redeemable
Ordinary (or deferred) annuity; annuity due
ordinary annuity(deffered annuity): Equal monthly or annual cashflows( inflows or outflows) which starts only after certain time period has lapsed. annuity due: Equal periodic cashflows which needed to be paid for certain period of time
c. Annuity; lump-sum payment; cash flow; uneven cash flow stream
Annuity: Equal monthly,yearly,semiannual or quaterly payments or receipts.(periodic equal cash inflows or outflows) lumpsum payment : One shot payment cash flow: capital/money inflows or outflows uneven cash flow stream: unequal money inflow or outflow
Effective annual rate (EAR or EFF%); nominal (quoted) interest rate; APR; periodic rate
Effective annual rate- This is the rate that is actually earned or paid on an inestment or a loan. This rate is used to compare the financial products that provide compounded interest rates. Formula- EAR = (1+ i / n)n - 1 Where i = Interest rate and n = number of compounding periods Nominal Interest Rates- Nominal interest rate is the rate that does not consider inflation. It is the stated interest rate on an instrument. It does not take into consideration the fees. Formula- Nominal Interest rate = Real interest rate + Inflation rate Annual Percentage rate(APR)- It is the actual yearly cost of fund for a particular year. It includes fees and processing charges. APR is mostly used by credit card companies and mortgage loan. APR can be fixed or variable over a period of time. Periodic rate- It is nothing but the APR for a shorter period of time. Formula- Periodic rate = APR / Number of billing periods
Would you rather have a savings account that pays 5% interest compounded semiannually or one that pays 5% interest compounded daily? Explain.
I would rather have a saving account that pays 5% interest compounded daily thancompounded semiannually because effective rate of semiannual interest rate is5.063% while effective rate of daily compounding is 5.13%.Calculation of interest compounded semiannually = (1+ Inom )M - 1.0 = (1 + 0.05/2)2 - 1 = (1.025)2 - 1 = 1.050625 - 1 = 5.063% Calculation of interest compounded daily= (1+ Inom)M - 1.0 = (1 + 0.05/365)365 - 1 = (1.0001369)365 - 1 = 1.05126 - 1 = 5.13%
An annuity is defined as a series of payments of a fixed amount for a specific number of periods. Thus, $100 a year for 10 years is an annuity, but $100 in Year 1, $200 in Year 2, and $400 in Years 3 through 10 does not constitute an annuity. However, the entire series does contain an annuity. Is this statement true or false?
The above statement is true because annuity is a series of payment at fixed intervals over a fixed number of years or over a life time. To be annuity it is necessary to be fixed amount. The second series is irregular cash flow but still constitute series of an annuity.
If a firm's earnings per share grew from $1 to $2 over a 10-year period, the total growth would be 100%, but the annual growth rate would be less than 10%. True or false? Explain.
True, because of compounding effects--growth on growth. The following example demonstrates the point. The annual growth rate is I in the following equation: $1(1 + i)10= $2. The term (1 + i)10 is the FV IF for i percent, 10 years. We can find i in one of two ways: 1. Using a financial calculator input N = 10, PV = -1, PMT = 0, FV = 2, and I =? Solving for I you obtain 7.18%. 2. Using a financial calculator, input N = 10, I = 10, PV = -1, PMT = 0, and FV =? Solving for FV you obtain $2.59. This formulation recognizes the "interest on interest" phenomenon.
Define each of the following terms: a. PV; I; INT; FVN; PVAN; FVAN; PMT; M; INOM
a) PV: Present Value means present value or worth as of today of probable future cashflows disounted at a specific rate. I or INT = interest rate or the discount factor. FVN: Value of today's cashflow at a future date. PVAN: Present Value of Annuity means present value of uniform future cash flows FVAN: Future Value of annuity means Future value of uniform present cash flows PMT: Stands for Payment usually equal yearly or monthly payments. M: Month INOM: monthly interest rate
