Chapter 29
Basic Financial Tools:
A Review
ANSWERS TO ENDOFCHAPTER QUESTIONS
291
a.
PV (present value) is the value today of a future payment, or stream of payments,
discounted at the appropriate rate of interest.
PV is also the beginning amount that
will grow to some future value.
The parameter I is the periodic interest rate that an
account pays.
FV
n
(future value) is the ending amount in an account, where n is the
number of periods the money is left in the account.
PMT is equal to the dollar
amount of an equal or constant cash flow (an annuity).
In the EAR equation, m is
used to denote the number of compounding periods per year, while i
Nom
is the
nominal, or quoted, interest rate.
b.
FVIF
i,n
is the future value interest factor for a lump sum left in an account for n
periods paying i percent interest per period.
PVIF
i,n
is the present value interest
factor for a lump sum received n periods in the future discounted at i percent per
period.
FVIFA
i,n
is the future value interest factor for an ordinary annuity of n
periodic payments paying i percent interest per period.
PVIFA
i,n
is the present value
interest factor for an ordinary annuity of n periodic payments discounted at i percent
interest per period.
All the above factors represent the appropriate PV or FV
n
when
the lump sum or ordinary annuity payment is $1.
Note that the above factors can also
be defined using formulas.
c.
The equivalent (effective) annual rate (EAR) is the rate that, under annual
compounding, would have produced the same future value at the end of 1 year as was
produced by more frequent compounding, say quarterly.
The nominal (quoted)
interest rate, i
nom
, is the rate of interest stated in a contract.
If the compounding
occurs annually, the effective annual rate and the nominal rate are the same.
If
compounding occurs more frequently, the effective annual rate is greater than the
nominal rate.
d.
An amortization schedule is a table that breaks down the periodic fixed payment of
an installment loan into its principal and interest components.
The principal
component of each payment reduces the remaining principal balance.
The interest
component is the interest payment on the beginningofperiod principal balance.
An
amortized loan is one that is repaid in equal periodic amounts (or retired over time).
Answers and Solutions:
29  1
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e.
The par value is the nominal or face value of a stock or bond.
The par value of a
bond generally represents the amount of money that the firm borrows and promises to
repay at some future date.
The par value of a bond is often $1,000, but can be $5,000
or more.
The maturity date is the date when the bond’s par value is repaid to the
bondholder. Maturity dates generally range from 10 to 40 years from the time of
issue.
A call provision may be written into a bond contract, giving the issuer the
right to redeem the bonds under specific conditions prior to the normal maturity date.
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 Spring '10
 KIENQUOCVANPHAM
 Management, Time Value Of Money, Future Value, Interest

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