FINA 2700 Lecture Notes - Lecture 5: Discounting, Effective Interest Rate, Compound Interest

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Simple interest: interest is earned only on the original investment, example: you invest in an account paying simple interest at the rate of 6% per year. Invest money at time 2, and future value at time 4, t is 2. Compound interest: interest is earned on the value of money that is in the account at the (cid:271)eginning of the period. Thus, the pre(cid:448)ious period(cid:859)s earned interest can also earn interest on the next period: example: you invest in an account paying compound interest at the rate of 6% per year. How much will the account be worth in 8 years: fv = x (1+r)t = x (1 + 0. 05)8 = . 45. Present values: present value is the value today of a future cash flow, how much do you need to invest today into an account paying compound interest at the rate of 5% per year, in order to receive.

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