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Unformatted text preview: Finance Test 2 Study guide Chapter 5: Time Value of Money Terms Time line-horizontal line on which time zero appears on the left side and future value periods are marked from left to right; can be used to depict investment cash flows. Compound interest- Interest earned on a given deposit that has become part of the principal at the end of a specified period. Principal- The amount of money on which interest is paid Future value- The value of a present amount at a future date, found by applying compound interest over a specified amount of time. Future value interest factor- The multiplier used to calculate, at a specified interest rate, the future value of a present amount as of a given time. Present value- The current dollar value of a future amount; the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount. Discounting cash flows- The process of finding present value; the inverse of compounding interest. Present value interest factor- The multiplier used to calculate, at a specified discount rate, the present value of an amount to be received in a future period. Annuity- A stream of equal periodic cash flows, over a specified time period. These cash flows can be inflows of returns earned on investments or outflows of funds invested to earn future values. Ordinary annuity- An annuity for which the cash flow occurs at the end of each period Annuity due- An annuity for which the cash flow occurs at the beginning of each period Future value interest factor for a annuity- The multiplier used to calculate the future value of an ordinary annuity at a specified interest rate over a given period of time. Present value interest factor for an annuity- The multiplier used to calculate the present value of an ordinary annuity at a specified discount rate over a given period of time. Perpetuity- An annuity with an infinite life, providing continual annual cash flow. Mixed stream- a stream of unequal periodic cash flows that reflect no particular pattern. Semiannual compounding- Compounding of interest over two periods within the year. Quarterly compounded- compounding of interest over four periods within the year. Continuous compounding- Compounding of interest an infinite number of times per year at intervals of microseconds. Nominal (stated) interest rate- Contractual annual rate of interest charged by a lender or promised by a borrower. Effective (true) annual rate (EAR)- The annual rate of interest actually paid or earned. Annual percentage rate (APR)- The nominal annual rate of interest, found by multiplying the periodic rate by the number of periods in 1 year, that must be disclosed to consumers on credit cards and loans as a result of truth-in-lending laws Annual percentage yield (APY)- The effective annual rate of interest that must be disclosed to consumers by banks on their savings products as a result of truth-in-...
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