RSM332H1 Lecture 3: Class 3

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Time value of money: simple and compound interest, interest rates, annuity and perpetuity, quoted vs effective rates. Simple interest interest paid or received only on initial investment. Compound interest paid on initial investment plus interest you receive. Bank of canada rate overnight interest rate between financial institutions. Due to reserve rate, some banks need to trade to achieve target. Prime rate rate charged to their best corporate customers (for us, prime rate = fed funds target. Annuity constant flow over a number of periods. Starts at time 1 and lasts for finite t periods (ex: mortgage loan) Very important does not start at t=0. Pv of perpetuity with cash flow c = 100 and interest rate r = 10% (p = c/r) Annuity due is structured so that the cash flows are paid at the beginning of a period rather than the end. Annuity due has a higher pv than ordinary annuity.

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