2007 Chapters 4-5-1

2007 Chapters 4-5-1 - 1 Chapters 4-5 2 Nominal Interest...

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Unformatted text preview: 1 Chapters 4-5 2 Nominal Interest Rate Stated interest rate per period of compounding i.e. 1% per month 12% per year 3 Effective Interest Rate The one rate that truly represents the interest earned in a year or some other time period. P = $1 i = 12% / 12 periods compounded monthly, N = 12 F = P (1 + .01) 12 = 1.1268 effective interest rate = 12.68% 4 Continuous Compounding i annual effective = e r 1 where r = nominal interest rate 5 Changing Interest Rates For single constant rates F = P (1 + i) N To allow for changing rates F = P (1 + i 1 )(1 + i 2 ).... )(1 + i N-1 )(1 + i N ) P = F (1 + i 1 )(1 + i 2 )....(1+ i N ) 6 Series of Cash Flows P = A + A 1 (1 + i 1 )-1 + A 2 (1 + i 1 )-1 (1 + i 2 )-1 +.... A N (1 + i 1 )-1 (1 + i 2 )-1 .... (1 + i N )-1 7 Expected Rate of Return = Risk-Free real return + Inflation factor + Risk Premium Broader diversification reduces risk! 8 Project Cash Flows Year Cash Inflows Cash Outflows Cash Flows n (Benefits) (Costs) 1 2 3 4 : : N Can also draw cash flow diagram....
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2007 Chapters 4-5-1 - 1 Chapters 4-5 2 Nominal Interest...

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