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FIN 612 (1)


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Ryerson University
FIN 612
Cynthia Holmes

Chapter 03Mortgage Loan Foundations The Time Value of MoneySolutions to QuestionsChapter 3Mortgage Loan Foundations The Time Value of MoneyQuestion 31What is the essential concept in understanding compound interestThe concept of earning interest on interest is the essential idea that must be understood in the compounding process and is the cornerstone of all financial tables and concepts in the mathematics of financeQuestion 32How are the interest factors IFs Exhibit 33 developed How may financial calculators be used to calculate IFs in Exhibit 33Computed from the general formula for compounding for monthly compounding for various combinations of i nand yearsFVPV x 1iCalculators can be used by entering1 for PV the desired values for n and i andsolving for FV Question 33What general rule can be developed concerning maximum values and compounding intervals within a yearWhat is an equivalent annual yield Whenever the nominal annual interest rates offered on two investments are equal the investment with the more frequent compounding interval within the year will always result in a higher effective annual yieldAn equivalent annual yield is a single annualized discount rate that captures the effects of compounding and if applicable interest rate changesQuestion 34What does the time value of money TVM meanTime value simply means that if an investor is offered the choice between receiving 1 today or receiving 1 in the future the proper choice will always be to receive the 1 today because that 1 can be invested in some opportunity that will earn interestPresent value introduces the problem of knowing the future cash receipts for an investment and trying to determine how much should be paid for the investment at presentWhen determining how much should be paid today for an investment that is expected to produce income in the future we must apply an adjustment called discounting to income received in the future to reflect the time value of moneyQuestion 35How does discounting as used in determining present value relate to compounding as used in determining future valueHow would present value ever be usedThe discounting process is a process that is the opposite of compoundingTo find the present value of any investment is simply to compound in a reverse senseThis is done by taking the reciprocal of the interest factor for the compound value of 1 at the interest rate multiplying it by the future value of the investment to find its present valuePresent value is used to find how much should be paid for a particular investment with a certain future value at a given interest rateQuestion 36 What are the interest factors IFs in Exhibit 39How are they developed How may financial calculators be used to calculate IFs in Exhibit 392Compound interest factors for the accumulation of 1 per period eg1 x 11i1i etc Calculators may be used by entering1 values for PMT entering the desired values for n and ithen solving for FVQuestion 37What is an annuityHow is it definedWhat is the difference between an ordinary annuity and an annuity dueAn annuity is a series of equal deposits or paymentsAn ordinary annuity assumes payments or receipts occur at the end of a periodAn annuity due assumes deposits or payments are made at the beginning of the period31
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