# Lesson5 - Lesson5 Lesson5 SuggestedReading:RSUChapters4and5

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Lesson 5: Lesson 5: The Structure of Interest Rates and  The Structure of Interest Rates and  the Determination of Present Value the Determination of Present Value In this lesson we learn about the universal arithmetic of  Present Value and see how these concepts can also be  related to explain the term structure of interest rates. Suggested Reading: RSU Chapters 4 and 5

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Some Preliminary Notes Difference between simple and compound interest  simple  Simple interest = P(r x t) Compound interest = P(1+r) t Relationship between real and nominal rates of  interest The Fisher Effect Nominal rate = Real rate + the expected rate of  inflation r = i +  π e
Exhibit 1a  The Relationship Between Present and  Future Values: Accumulation (different interest rates) Present Value        Future Value 1 1 1 2 1 2 2 n 1 2 n n PV = \$1 \$1+r = FV PV = \$1 \$(1+r )(1+r ) = FV ... ... PV =

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