Intro Statistics - Mathematics of Finance Lecture 12...

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Unformatted text preview: Mathematics of Finance Lecture 12 Interest Rates and Economic Theory Why, when you deposit money in a savings account, does the bank pay you interest? Interest Rates and Economic Theory Why, when you borrow money to purchase a home, car or holiday, does the lender charge you interest? The Rate of Interest in the Real World Different rates of interest coexist and fluctuate over time. “Nominal" rate of interest: n r = r + d + p Real rate of interest “r” Risk premium “d” Expected changes in the price level “p” Simple Interest Calculated on the original principal Sum accrued (aka investment's future value) S = P + P*r*n Compound Interest aka "interest on interest“ Most lenders or investors demand that any interim interest rewards earned over the term of investment, if not paid when earned, be treated as an additional investment. Compounded Annually Compounded More than Once Per Year Compounded Continuously Interest Compounded Annually Suppose an amount $P is invested for one year at a rate of r per annum. The amount accrued including interest After one year is After two years: After three years: After n years: Interest Compounded Annually: Example Suppose a principal of $5000 is to be invested at an annual rate of 15% for five years. What amount is available on maturity? Interest Compounded More than Once Per Year Often interest rates are compounded on a monthly, weekly or even a daily basis (although still quoted on an annual basis)....
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This note was uploaded on 11/06/2011 for the course ECMT 1010 taught by Professor Vadimtimovsky during the Three '10 term at University of Sydney.

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Intro Statistics - Mathematics of Finance Lecture 12...

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