BA 103 Lec 6

BA 103 Lec 6 - UGBA 103 Personal Finance Lecture 6...

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UGBA 103 Personal Finance Lecture 6 (2/13/08) POWERPOINT #4: TIME VALUE APPLICATION TO MORTGAGE LOANS C can be divided into 2 pieces. (1) is interest payment. (2) is amount so that at end of the 30 years you won’t owe anything r= monthly interest rate PV 0 (C 1 , C 2 , C 3, C t ,,…, C n ,) = (C/r)[1-(1/(1=r) N )] APPLICATION TO MORTGAGE LOANS (CONT) Interest payments gradually decrease, principal payments gradually rise At end of time period, last payment will bring balance to 0 Can look INTERNAL RATE OF RETURN IRR=interest rate r which sets the NPV of a series of cash flows Level of r that solves NPV=0 POWERPOINT #5: INTEREST RATE ANNUAL VS. MNTHLY COMPOUNDING Monthly compounding is better because you want to earn interest on interest Example: 1 st month 1.0075 2 nd month 1.0075 =(1.0075)(1.0075) Compounding lets interest be applied to 1+interest What does r have to be to give me annual interest rate? (1+r m ) 12 =1+r a GENERAL IDEA INTEREST RATE QUOTES Note difference between APR and interest rates ANNUAL PERCENTAGE RATE (APR) APR= ignore ability to earn interest on interest throughout the year Also called simple interest rate It should not be used in NPV calculations EAR= effective annual rate, compounds interest rate Ex. EAR=(1.0075) 12 vs. APR= .05/.75 EAR>APR because allow you to earn interest upon interest EXAMPLE 3 month bond, 8% APR
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Interest rate you have to pay is APR= 08/4)2%, But 8% is not paid at end of year, but paying 4 installments at 2% each installment EFFECTIVE ANNUAL RATE Assumes interest is paid as you go along Example: EAR = (1+r) 4 =1.08 Interest rate is less than 2% because if pay as you go along, you get to pay less money as you go
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BA 103 Lec 6 - UGBA 103 Personal Finance Lecture 6...

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