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# Lecture2 - LECTURE 2 TIME VALUE OF MONEY COMPOUND INTEREST...

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L ECTURE 2 T IME V ALUE OF M ONEY : C OMPOUND I NTEREST , P RESENT & F UTURE V ALUES Reading: Chapter 3, sections 3.1-3.4, Chapter 4 Sections 4.1-4.2 Chapter 5, Section 5.1 Practice Problems: Lecture 2 online, due next time Objectives 1. Explain and understand compound interest 2. Compute the present or future value of any cash flow using any compounding interval 3. Understand the concept of Net Present Value and how it relates to the Law of One Price 4. Solve for present value, future value, interest rate or number of periods, given the values of the other thre 5. Derive an effective annual compound rate of interest (also called APY) from an annual percentage rate of interest (APR)

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M OVE - IN S PECIALS When I moved into my apartment three years ago, my landloard had a “move-in special.” Rent on my apartment is \$1350/month However, because of the “move-in special,” the landlord offered to lower my rent to \$1125 per month for six months (which was my lease term). Alternatively, I could live rent-free for the first month, and then pay \$1350 per month for the remaining five months of my lease. Which option would you take? How can we think of this as a saving/investment problem?
I NTRODUCTION TO THE TIME VALUE OF MONEY : Easy: Choice between \$100 and \$110 right now. Not so easy: Choice between \$100 today and \$110 in 1 year. Let’s apply the Law of One Price : How can we determine the current market price of the right to receive \$110 in 1 year? Many business and personal decisions involve a trade-off of cash flow between points in time. What are some examples? We need market interest rates and the tools of interest rate mathematics to compare bundles or streams of cash flows over time. Present Value Æ Compound interest Æ Future Value Present Value Å Discounting Å Future Value

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C ALCULATING F UTURE V ALUE Suppose you place \$100 in a CD that earns 2% interest compounded annually.
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Lecture2 - LECTURE 2 TIME VALUE OF MONEY COMPOUND INTEREST...

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