Sess0304 new

Sess0304 new - Fin3715 Fall 07 - Kayhan 1 Lecture 3-4:...

Info iconThis preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Fin3715 Fall 07 - Kayhan 1 Lecture 3-4: Perpetuities and Annuities Reading: RWJ Chapter 6 Outline: Compounding Frequency Perpetuities and Annuities Applications Fin3715 Fall 07 - Kayhan 2 Compounding Frequency (Intervals) Stated Annual Interest Rate (SAR) Interest rate that is stated in contracts using simple interest (compounding period must be given). 12% compounded quarterly = 3% per quarter 12% compounded monthly = 1% per month Examples : Loans with monthly payments (e.g. car loans and mortgages) are compounded monthly. Many bonds (e.g., US Govt bonds) are compounded semi-annually. Fin3715 Fall 07 - Kayhan 3 Whats the FV of $100 invested for 2 years earning 10% compound semi-annually? Fin3715 Fall 07 - Kayhan 4 Whats the FV of $100 invested for 2 years earning 10% compound semi-annually? 5 % 100 Period 4 3 2 1 Period = half a year # period per year: m = 2 Total number of periods = m*2 = 4 Interest rate per period: r SAR /m = 10%/2 = 5% FV = 100 (1+5%) 4 = 121.55 Fin3715 Fall 07 - Kayhan 5 Effective Annual Rate Effective Annual Interest Rate (EAR) Interest rate that is annualized using compound interest. r EAR = (1 + r SAR /m) m 1 Remark: The rate over the same period (e.g. EAR) must be used to compare rates of return between two investments with different periods (e.g., monthly versus quarterly). If m > 1, the EAR will always be greater than the SAR. Fin3715 Fall 07 - Kayhan 6 Example 1: Effective Annual Rate Given a monthly rate of 1%, What is the Effective Annual Rate (EAR)? What is the Stated Annual Rate (SAR)? Fin3715 Fall 07 - Kayhan 7 Example 1: Effective Annual Rate (Soln) EAR = (1+.01) 12- 1= 12.68% SAR = (.01) (12) = 12% Fin3715 Fall 07 - Kayhan 8 Example 2: Effective Annual Rate You purchase a 30-year $1,000 CD today. Whats your account worth when it matures, if the interest is 10% compounded (i) annually, (ii) quarterly, (iii) monthly, (iv) daily? Fin3715 Fall 07 - Kayhan 9 Example 2: Effective Annual Rate (Soln) 1000 (1+.1) 30 = 17,449.4 1000 (1+.1/4) 4*30 = 19,358.1 1000 (1+.1/12) 12*30 = 19,837.4 1000 (1+.1/365) 365*30 = 20,077.3 Remark : More frequent compounding does not add much value beyond the monthly frequency. Fin3715 Fall 07 - Kayhan 10 Example 3: Effective Annual Rate You want to invest $1,000 in a savings account for two years. After visiting three different banks, you discover the following three options: (i) 12.5% compounded annually; (ii) 11.75 % compounded monthly; (iii) 12% compounded quarterly. Which savings account should you choose? Fin3715 Fall 07 - Kayhan 11 Example 3: Effective Annual Rate (Soln) (i) EAR = 12.5%; (ii) EAR = (1+.1175/12) 12 1 = 12.40% (iii) EAR = (1+.12/4) 4 1 = 12.55% Thus, choose 3 rd option. Fin3715 Fall 07 - Kayhan 12 PV of Multiple Cash Flows 1 2 T r % CF CF T CF 2 CF 1 Period Remark: To calculate the PV (FV) of a stream of cash...
View Full Document

Page1 / 45

Sess0304 new - Fin3715 Fall 07 - Kayhan 1 Lecture 3-4:...

This preview shows document pages 1 - 13. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online