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Chapter_6_Class_Notes_Solutions

Chapter_6_Class_Notes_Solutions - Chapter 6 Class Notes...

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1 Chapter 6 Class Notes Simple interest vs. Compound interest: o Simple interest amount = Principal * annual interest rate * period o Compound interest amount includes interest not only on the initial investment but also on the accumulated interest in previous periods. Example: Assume we will save $1,000 for three years and earn 6% interest compounded annually. Time value of Money: 1. A single sum: Assume we will save $1,000 for three years and earn 6% interest compounded annually. On 1/1 in Year 1: $1,000 on Dec. 31 in Year3: $ 1,191.02 (a) Future value of a single sum = Present value * (1+ r) n Future value of $1000 after 3 years: $1,000 × [1.06] 3 = $1,191.02 (b) Present value of a single sum = Future value *( 1/ (1+ r) n ) Present value of $1,192.02: $1,191.02 × (1/ [1.06] 3 )= $1,000 Where r = interest rate n= compounding periods Original balance 1,000.00 $ First year interest 60.00 Balance, end of year 1 1,060.00 $ Balance, beginning of year 2 1,060.00 $ Second year interest 63.60 Balance, end of year 2 1,123.60 $ Balance, beginning of year 3 1,123.60 $ Third year interest 67.42 Balance, end of year 3 1,191.02 $
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