FIN 3000 EXAM 2

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Compounding

calculates the future value of present money by adding interest on both principal and accumulated interest

The process of accumulating interest on an investment over time to earn more interest

Discounting

determines the present value of future money by reversing the compounding process.

Simple interest

Interest earned per year only on the original principal amount invested (principal * int rate)

Compound interest

interest earned on both the initial principal and the interest reinvested from prior periods.

decreases the present value

What happens to the present value of future cash flows if the discount rate

increases?

Rule of 72

quick way to estimate how long it takes an investment to double in value.

6-10%

Within what range of interest rates is it applicable to use the law of 72

nominal interest rate

the stated interest rate on a loan

EAR is actual rate after compounding

What is the difference between a simple interest

rate (APR) and an effective annual interest rate?

annuity

level stream of cash flows for a fixed period of time

Ordinary annuity

Payments are made at the end of each period.

Annuity due

Payments are made at the beginning of each period.

Perpetuity

an annuity in which the cash flows continue forever

increases the present value of an annuity

What happens to the present value of an annuity if the discount rate decreases?

Pure discount loan

When someone borrows money and pays no interest

Interest-only loan

When an entity borrows money and only pays interest payments and pays back the money they borrowed as well as the final interest payment

Amortized loan

A loan where the principal of the loan is paid down over the life of the loan (that is, amortized) according to an amortization schedule, typically through equal payments.