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CHAPTER 5

# CHAPTER 5 - Inflation VALUE VALUE ASSUMPTIONOF COMPOUNDING...

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Opportunity cost of lost income from investments Cost of deferring consumption Inflation
Moving sums of money through time WITHOUT  CHANGING ITS RELATIVE EQUIVALENCY Moving forward – COMPOUNDING – FUTURE  VALUE Moving backward – DISCOUNTING – PRESENT  VALUE

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ASSUMPTION OF  COMPOUNDING ALL CASH FLOWS ARE REINVESTED  AT THE  SAME RATE  AS THE ORIGINAL INVESTMENT
PV = Present Value (time zero) FV = Future Value PMT = Annuity Payments i = annual rate of interest (increase) N = number of years of compounding/discounting i/y = Periodic interest rate CF = Cash Flow (of particular period)

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Lump Sum – how much will \$1000 invested today  in an account that pays an annual interest rate of  10%? Year 1 = 1000  + 1000*1.10 = \$1100 Year 2 = 1100 + 1100*1.10 = 1210 Year 3 = 1210  + 1210*1.10 = 1331 SUMMARIZE = FVn = PV(1+i) n FV = 1000(1.10) 3  = 1331
Financial Calculator: Enter what you know – compute what want to know 1000 hit PV 3 hit n 10 hit I/Y Hit CPT hit FV

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Nominal or annual rate/number of compounding  periods per year Compute M = number of compounding periods Example:  10% nominal rate, semi-annual  compounding: 1/y = 10/2 = 5%; M = 3X2 = 6.  Solve like before 1000=PV; 6=n; 5=i/y CPT FV     answer 1340.10 WHY HIGHER VALUE????
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CHAPTER 5 - Inflation VALUE VALUE ASSUMPTIONOF COMPOUNDING...

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