This preview shows pages 1–3. Sign up to view the full content.
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
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentInterest 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
This is the end of the preview. Sign up
to
access the rest of the document.
 Spring '07
 Berk

Click to edit the document details