ch.5 finance

true

(APR/m) is the periodic rate. true or false

Interest Rate Factor

1+r

d. Both B & C

1. The concept of opportunity cost is described in which of the following statements? a. The monetary value of an exchange of goods for services or the opportunity to do something b. The value of what certain resources could have produced had they been used in the best alternative way c. The cost of choosing between two alternatives d. Both B & C

discount factor

1/(1+r)

Law of One Price

2 assets with the same cash flows must sell for the same price; no arbitrage

- B: reducing the value of future cash flows

2. What is discounting? - A: calculating the future vale of a cash flow - B: reducing the value of future cash flows - C: adding inflation risk

C/Y

= enter number of compounding periods per year

Annuity

A series of equal payments at fixed intervals for a specified number of periods

Equivalent Annual Rate (EAR)

EFF%, annual rate of interest actually being earned, as opposed to the quoted rate

Timeline

Important tool used in time value analysis; it is a graphical representation used to show the timing of cash flows

Use the given APR and given compounding period to find the periodic rate.

Iperiodic=APR/m

true

Is this statement true or false? A rational person should choose to receive cash flows from an annuity due of $1,000 per year rather than from a similar ordinary annuity.

perpetuity

It is simply an annuity with an extended life. Because the payments go on forever, you can't apply the step-by-step approach

Compunding

Process of determining the final value of a cash flow or series of cash flows when compound interest is applied

quoted

Remember that the APR is the ______ rate

Uneven Cashflows

Series of cash flows where the amount varies from one period to the next

true

T/F": An amortized loan is a type of loan that requires regular, fixed payments over the life of the loan with the loan balance decreasing over time

true

T/F: Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment.

false

T/F: If the interest rate is greater than zero, then the future value of an ordinary annuity is greater than the future value of an annuity due. This occurs because the last payment of the ordinary annuity earns interest, while the last payment of the annuity due does not.

true

T/F: opportunity cost is subjective. It is up to you to decide what the best alternative use of resources is.

false

TRUE OR FALSE: The "cost" referred to in the concept of opportunity cost is always monetary.

APR

The _____ is the annual rate that is quoted by law - But it is not actually a useful annual rate, despite its name. It uses simple, rather than compound, interest.

Annual compounding

The arithmetic process of determining the final value of a cash flow or series of cash flows when interest is added once a year.

Semiannual Compounding

The arithmetic process of determining the final value of a cash flow or series of cash flows when interest is added twice a year.

FVAn

The future value of an annuity over N periods

Discounting

The process of finding the present value of a cash flow or a series of cash flows; discounting is the reverse of compounding.

false

True or false: A deposit will grow faster if simple interest rather than compound interest is paid

false

True or false: A dollar today is worth less than a dollar tomorrow

true

True or false: An annuity due is like an ordinary annuity with the exception that payments occur at the beginning of each period, instead of at the end of each period.

true

True or false: The general assumption in finance is that annuity payments occur at the end of the period, so this type of payment is referred to as an ordinary annuity

true

Under an amortized loan, the periodic payments are all equal. However, the fraction of the payment that represents interest declines over time. True or false? =

interest rate

____ ___ is what allows us to convert cash across time (also called the "discount rate", "cost of capital" or "required return" in various contexts)

true

a lender should prefer to lend at a rate of 10% with semiannual compounding, but a borrower would prefer a loan with a rate of 10%, annual compounding. True or false?

Amortized Loan

a loan that is repaid in equal payments over its life. A loan that is to be repaid in equal amounts on a monthly, quarterly, or annual basis.

Perpetuity

a stream of equal payments at fixed intervals expected to continue forever

annuity due

an annuity for which the cash flows occur at the beginning of the period; BEGIN MODE

Ordinary (or deferred) Annuity

an annuity whose payments occur at the end of each period; END MODE

Cash Flow (CFt)

cash flow that's not part of an annuity

annuity

cash flows are all the same amount, and spread out equally over a finite period of time. $1000 per year for 5 years, e.g.

perpetuity

cash flows are same amount, over regular intervals, but forever. (THERE IS NO END)

Payment (PMT)

equal cash flows coming at regular intervals

Compound Interest

occurs when interest is earned on prior periods' interest

Simple Interest

occurs when interest is not earned on interest

True

t/f: The APR is simply the periodic rate times the number of periods.

True

t/f: discounting in finance: means reducing future cash flows to their present value

Future Value (FV)

the amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate

Nominal Interest Rate (Inom)

the contracted interest rate, APR

BA II: + #

the formula for 'Cash inflow' on calculator

BA II: - #

the formula for 'Cash outflow' on the calculator

PVAn

the present value of an annuity of N periods

Opportunity Cost

the rate of return you could earn on an alternative investment of similar risk

Opportunity cost

the value of what certain resources COULD produce had they been used in the best alternative way

Present Value (PV)

the value today of a future cash flow or series of cash flows

amortized loans

this loan is when interest decreases over year, principal increases and Payment stays the same* = ___________

false

true or false: Mortgages, car loans, and student loan are not examples of amortized loans.

partially amortized loan

•Also known as a "balloon" mortgage. For example: "7/23 balloon" would be a 30-year mortgage where you make monthly payments for 7 years, then pay off the principal balance of the remaining 23 years, usually by refinancing.

amortized loans

•Each payment contains some principal and some interest. When you make the last payment, your balance hits zero and you own the asset in full. Car loans, mortgage loans, student loans, etc.

interest only loans

•Interest is paid every period; principal is paid at expiration (if at all). Frequently used during the housing bubble. Most bonds are examples.

ICONV

•The _______ function on the BA-II Plus makes converting from APR to EAR and vice versa much easier

Law of One Price:

•Two assets with the same cash flows must sell for the same price; no arbitrage

Present Value

•today's value of money you expect to receive in the future.

future value

•value of today's money at some point in the future.