Theory of Interest Basic Concepts

Interest Rate

The ratio of the amount of interest earned or paid over a specified period to the principal amount.

Present Value

The current worth of a future sum of money given a specified rate of return.

Effective Annual Rate (EAR)

The interest rate on an investment or loan that is compounded annually.

Nominal Rate

The interest rate before adjustment for inflation, typically annually.

Discount Rate

The interest rate used to determine the present value of future cash flows.

Force of Interest

The instantaneous or continuous rate at which interest accumulates on an investment.

Compounding

The process of earning interest on both the principal and the previously accumulated interest.

Simple Interest

Interest calculated only on the principal amount, not on the interest already earned.

Future Value

The value of an investment at a specified date in the future, based on an assumed rate of growth.

Annuity

A series of equal payments made at regular intervals over time.

Cash Flow

The total amount of money being transferred in and out of a business.

Internal Rate of Return (IRR)

The discount rate that makes the net present value (NPV) of all cash flows equal to zero.

Investment

The action or process of investing money for profit.

Amortization

The process of gradually paying off a debt over time through regular payments.

Net Present Value (NPV)

The difference between the present value of cash inflows and the present value of cash outflows over a period.

Liquidity

The ease with which an asset can be converted into cash without affecting its market price.

Diversification

The strategy of spreading investments across different financial assets to reduce risk.

Risk Tolerance

An investor's ability and willingness to endure fluctuations in the value of their investments.

Capital Gains

The profit realized from the sale of an asset that has increased in value.

Equity

The value of an ownership interest in an asset, calculated as the market value minus any debts associated with that asset.

Debt-to-Equity Ratio

A measure of a company's financial leverage, calculated by dividing total liabilities by shareholders' equity.

Yield

The income returned on an investment, typically expressed as a percentage of the investment's cost.

Brokerage

A financial service that facilitates the buying and selling of securities on behalf of clients.

Total Return

The overall return on an investment, including both capital gains and income received.

Risk-Adjusted Return

A measure that compares the return of an investment to its risk, often used to evaluate performance.

Market Capitalization

The total market value of a company's outstanding shares, calculated as share price multiplied by total shares.

Asset Allocation

The process of dividing investments among various asset categories to manage risk and achieve investment goals.

Securities

Financial instruments that represent an ownership position or a creditor relationship.

Hedge Fund

A pooled investment fund that employs various strategies to earn high returns for its investors.

Venture Capital

Financing provided to startups and small businesses with long-term growth potential.

Financial Statement

Formal records of the financial activities of a business, person, or entity.

Bond

A fixed income investment that represents a loan made by an investor to a borrower.

Dividends

Payments made by a corporation to its shareholders, usually in the form of cash or additional stock.

Financial Modeling

The process of creating a representation of a financial situation or performance to predict future financial outcomes.

Asset

Any resource owned by an individual or entity that is expected to provide future economic benefits.

Debenture

A type of debt instrument that is not secured by physical assets or collateral.

Market Risk

The possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets.

Credit Risk

The risk of loss due to a borrower's failure to make payments on any type of debt.

Return on Investment (ROI)

A performance measure used to evaluate the efficiency of an investment or compare the efficiency of several investments.

Capital Structure

The mix of debt and equity financing used by a firm to fund its operations and growth.

Inflation Rate

The rate at which the general level of prices for goods and services is rising.

Mutual Fund

An investment vehicle that pools funds from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities.

Financial Ratios

Metrics used to evaluate the financial health and performance of a company, calculated from the financial statements.

Portfolio

A collection of financial investments like stocks, bonds, commodities, and cash equivalents.

Asset Management

The systematic process of developing, operating, maintaining, and selling assets in a cost-effective manner.

Leverage

Using borrowed capital for investment, expecting the profits made to be greater than the interest payable.

Credit Rating

An assessment of the creditworthiness of a borrower, predicting the likelihood of default.

Initial Public Offering (IPO)

The process of offering shares of a private corporation to the public in a new stock issuance.

Book Value

The net value of a company's assets as recorded on its balance sheet, minus liabilities.

Short Selling

The practice of selling securities that the seller does not own, with the intention of buying them back at a lower price.

Cost of Capital

The return expected by those who provide capital for a business, including debt and equity investors.

Market Order

An order to buy or sell a security at the current market price.

Stop Loss Order

An order placed with a broker to buy or sell once the stock reaches a certain price to limit potential losses.

Beta

A measure of a stock's volatility in relation to the overall market; a beta of 1 means it moves with the market.

Commodity

A basic good used in commerce that is interchangeable with other goods of the same type.

Financial Derivative

A security whose value is derived from the performance of an underlying asset, index, or rate.

P/E Ratio (Price-to-Earnings Ratio)

A valuation ratio calculated by dividing the market price per share by the earnings per share.

Treasury Bond

A long-term debt obligation backed by the U.S. Treasury Department with a fixed interest rate.

Blue Chip Stock

Shares of well-established companies with a history of reliable financial performance and dividends.

Exchange-Traded Fund (ETF)

A type of investment fund that tracks an index, commodity, or basket of assets and is traded on stock exchanges.

Yield Curve

A graph that shows the relationship between interest rates and the maturity of debt for a given borrower.

Accrual Accounting

An accounting method where revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged.

Financial Leverage

The use of borrowed funds to increase the potential return on investment.

Private Equity

Investment funds that typically buy and restructure companies that