FIN222 Lecture Notes - Lecture 2: Interest Rate, Interest
LECTURE 2. TIME
VALUE OF MONEY –
INTEREST RATES
Time value of money
Interest rate
adjustments
The amount of simple interest earned in one year is called Annual Percentage Rate
(APR)
The total actual amount of interest earned in one year is called Effective Annual
Rate (EAR) (annual growth rate that takes compounding into account)
EAR > APR when m > 1
Converting APR to EAR:
**Note: m is the number
of times per year that
interest is compounded
Valuing a
stream of CFs
Present value of a CF:
Document Summary
The amount of simple interest earned in one year is called annual percentage rate (apr) The total actual amount of interest earned in one year is called effective annual. Rate (ear) (annual growth rate that takes compounding into account) Ear > apr when m > 1. **note: m is the number of times per year that interest is compounded. Present value of a cf: (cid:1831) = (cid:4666)1+ (cid:1865) (cid:4667)(cid:3040) 1. Perpetuity is a stream of equal cfs c paid every period, forever. Deferred perpetuity: (cid:1870) (cid:4666)1+(cid:1870)(cid:4667) 1 (cid:4666)(cid:1868)(cid:1857)(cid:1870)(cid:1868)(cid:1857)(cid:1872)(cid:1873)(cid:1872)(cid:4667)= (cid:1870) (cid:4666)(cid:1856)(cid:1857)(cid:1858)(cid:1857)(cid:1870)(cid:1870)(cid:1857)(cid:1856) (cid:1868)(cid:1857)(cid:1870)(cid:1868)(cid:1857)(cid:1872)(cid:1873)(cid:1872)(cid:1857)(cid:1871)(cid:4667)= 1 (cid:4666)1+(cid:1870)(cid:4667) 1= (cid:4666)(cid:1859)(cid:1870)(cid:1867)(cid:1866)(cid:1859) (cid:1868)(cid:1857)(cid:1870)(cid:1868)(cid:1857)(cid:1872)(cid:1873)(cid:1872)(cid:4667)= (cid:1870) (cid:1859) (cid:4666)(cid:1856)(cid:1857)(cid:1858)(cid:1857)(cid:1870)(cid:1870)(cid:1857)(cid:1856) (cid:1859)(cid:1870)(cid:1867)(cid:1866)(cid:1859) (cid:1868)(cid:1857)(cid:1870)(cid:1868)(cid:1857)(cid:1872)(cid:1873)(cid:1872)(cid:1857)(cid:1871)(cid:4667)= 1 (cid:4666)1+(cid:1870)(cid:4667) 1= (cid:1870) (cid:1859) (cid:4666)1+(cid:1870)(cid:4667) 1. Annuity is a stream of equal cfs c paid every period for n periods. Present value of a annuities: (cid:4666)(cid:1866)(cid:1866)(cid:1873)(cid:1872)(cid:1857)(cid:1871)(cid:4667)= 1(cid:4666)1 1(cid:4666)1+(cid:4667)) (cid:1832) (cid:4666)(cid:1866)(cid:1866)(cid:1873)(cid:1872)(cid:1857)(cid:1871)(cid:4667)= 1(cid:1870)(cid:4666)(cid:4666)1+(cid:1870)(cid:4667)(cid:3041) 1(cid:4667) Solving for the number of periods (n): using natural logarithm. Nominal interest rates: interest rates quoted by banks and other financial institutions.