FIN 5013 Chp 5

Annuities

- A series of equal payments at regular intervals either made, received or both for a certain number of periods - When a payment is made at the end of each period, it is an ordinary annuity; when a payment is made in the beginning, it is an annuity due - Perpetuity is a series of payments made at fixed intervals that continue infinitely and can be thought of as an infinite annuity - Annuity due payments are made one period earlier than ordinary annuity payments, so they will earn interest for an additional period. Therefore, the value of an annuity due will be greater than the value of a similar ordinary annuity.

Investments and loans base their interest calculations on one of two possible methods

- Simple interest - Compound interest methods > Both apply three variables: amount of the principal, interest rate, investment or deposit period

Process of converting PV into FV is called

Compounding

Other things remaining equal, the present value of a future cash flow ________ if the discount rate ____________

Decrease, increase

After the end of the second year and all other factors remaining equal, a future value based on compound interest will never exceed the future value based on simple interest.

False

Perpetuity

Financial instrument that promises to pay an equal cash flow per period forever

Effective interest rate

Frequently greater than the nominal rate because of such factors as the frequency of compounding and the deduction of interest in advance - The actual rate of interest paid by the borrower or earned by the lender

Nominal interest rate

Periodic rate of interest that is stated in a loan agreement or security

Notice that the present value interest factor is the __________ of the future value interest factor.

Reciprocal

Rate of interest

The percentage on the principal that the borrower pays the lender per time period is compensation for forgoing other investment or consumption opportunities

Interest

The return earned by or the amount paid fo someone who has forgone current consumption or alternative investment opportunities and "rented" money in a creditor relationship

All other factors being equal, both the simple interest and the compound interest methods will accrue the same amount of earned interest by the end of the first year.

True

The process of earning compound interest allows a depositor or investor to earn interest on any interest earned in prior periods.

True

Annuity due is always _______ than that of an ordinary annuity

greater