fin management chapter 5

  1. Simple interest
    interest is earned only on principal
  2. compound interest
    an investment during the first period is added to the principal; then, during the second period interest is earned on the new sum (includes principals and interest earned so far)
  3. future value
    amount of sum will grow to in a certain number of years when compounded at a specific rate

    • FVN: future of the investment at end of "n" years
    • PV: PV, or original amount invested at the beginning of the first year
  4. how to increase the future value
    • increasing number of years compounding
    • increasing interest rate or discount rate
    • increasing original investment
  5. increase future value by
    increasing number of years for which money is invested and/or investing at higher interest rate
  6. present value
    reflects the current value of a future payment or receipt
  7. PV is lower if
    time period is longer and/or interest rate is higher
  8. Annuities
    FV of annuity, PV of annuity, annuities due
  9. annuity
    an annuity is a series of equal dollar payments for a specified number of years
  10. ordinary annuity
    payments occur at end of each period
  11. FV of an annuity is a compound annuity which is
    depositing or investing an equal sum of money at the end of each year for a certain number of years and allowing it to grow
  12. PV of an annuity
    pensions, insurance, obligations and interest owed on bonds are all annuities. to compare these three types of investments we need to know the present value of each
  13. Annuities due
    ordinary annuities in which all payments have been shift forward by one time period. thus with annuity due, each annuity payment occurs at the beginning of the period rather than at the end of the period
  14. Amortized Loan
    loans paid off in equal installments over time (home mortgages, auto loans)
  15. amortizing
    reducing the balance of a loan via annuity payments
  16. periodic payment is fixed in a
    amortized loans
  17. in an amortized loan each payment you owe
    less towards principal; amount that goes toward interest declines with every payment
  18. to make rates comparable we compute
    annual percentage yield (APY) or effective annual rate (EAR)
  19. quoted rate could be very different from effective rate if
    compounding is not done annually
  20. perpetuity
    annuity that continues forever
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fin management chapter 5
financial management chapter 5