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02_Time_Value_of_Money-Day_8

# 02_Time_Value_of_Money-Day_8 - Time Value of Money Day 8...

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Time Value of Money Thomas Hogan FNAN 301 February 22, 2011

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Agenda EAR APR Comparing EAR & APR
Rates and Compounding Compounding frequency refers to how often interest or returns are computed. Interest rates and returns are often stated in terms of their annual rate and the frequency of compounding. Examples: 10% compounded annually 12% compounded monthly Investments can have the same stated annual rate but different actual or "effective" interest rates depending on how often interest is compounded.

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Type of Periods 3 types of periods affect interest rates: Compounding period Payment period The period of the rate quotation Whichever of these has the smallest period, that's the type of period you use for calculations. Periods may be in any increment less than or equal to 1 year, but the most common are: Annual, monthly, quarterly, daily, semi-annual, and continuous (infinitely small periods).
Periodic Rates The "period rate" or "periodic rate" is the rate that is relevant for one period. Convert all numbers to the smallest of payment, compounding or quoted period before calculations. Examples: Payment for whole year but monthly rate. → Monthly Annual rate with quarterly payments. → Quarterly Annual rate with daily compounding. → Daily Rates are often quoted annually as an APR or EAR and must be converted to periodic rates.

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APR = Annual Percentage Rate APR is an approximation . To approximate the annual rate, we multiply the periodic rate by the number of periods in a year. APR = (# of periods per year) × periodic rate Best examples: Bonds rates are quoted in yield-to-maturity which is an APR (usually with semi-annual compounding). Credit cards are required by law to report the APR
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02_Time_Value_of_Money-Day_8 - Time Value of Money Day 8...

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