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#summary #tvm
  • The interest rate, r, is the required rate of return; r is also called the discount rate or opportunity cost.

  • An interest rate can be viewed as the sum of the real risk-free interest rate and a set of premiums that compensate lenders for risk: an inflation premium, a default risk premium, a liquidity premium, and a maturity premium.

  • The future value, FV, is the present value, PV, times the future value factor, (1 + r)N.

  • The interest rate, r, makes current and future currency amounts equivalent based on their time value.

  • The stated annual interest rate is a quoted interest rate that does not account for compounding within the year.

  • The periodic rate is the quoted interest rate per period; it equals the stated annual interest rate divided by the number of compounding periods per year.

  • The effective annual rate is the amount by which a unit of currency will grow in a year with interest on interest included.

  • An annuity is a finite set of level sequential cash flows.

  • There are two types of annuities, the annuity due and the ordinary annuity. The annuity due has a first cash flow that occurs immediately; the ordinary annuity has a first cash flow that occurs one period from the present (indexed at t = 1).

  • On a time line, we can index the present as 0 and then display equally spaced hash marks to represent a number of periods into the future. This representation allows us to index how many periods away each cash flow will be paid.

  • Annuities may be handled in a similar fashion as single payments if we use annuity factors instead of single-payment factors.

  • The present value, PV, is the future value, FV, times the present value factor, (1 + r)N.

  • The present value of a perpetuity is A/r, where A is the periodic payment to be received forever.

  • It is possible to calculate an unknown variable, given the other relevant variables in time value of money problems.

  • The cash flow additivity principle can be used to solve problems with uneven cash flows by combining single payments and annuities.

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