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topic 4 Interest rate

topic 4 Interest rate - INTEREST RATE Learning Objective...

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Learning Objective Understanding the Interest rate quotes and Adjustment Application of Interest rate in computing Loan Payments Studying the determinants of interest INTEREST RATE
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Prescribe book Berk,J. ,Demarzo,P. and Harford,J.,2009, Fundamentals of Corporate Finance , Pearson Education, Chapter 5.
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The effective annual rate The effective annual rate (EAR) or annual percentage yield (APY) indicates the total amount of interest that will be earned at the end of one year. Example 1: if EAR = 5%, a $100 investment will be: After 1 year? After 2 year?
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Adjusting the discount rate to different time periods Recall example 1: if the period is shorter than one year, what is the equivalent interest rate? Calculate it based on the interest rate factor (1+r) to the appropriate fractional power. Earning 5% interest in one year is equivalent to receiving for each $1 invested every six months. The equivalent interest rate of 5% annually for semiannually is 2.47% 0247 . 1 $ %) 5 1 ( 5 . 0 = +
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Adjusting the discount rate to different time periods Equivalent n-period discount rate = n can be >1 (to compute a rate over more than one period) or <1 (to compute a rate over a fraction of a period) When computing present or future value, you should adjust the discount rate to match the time period of the cash flows. 1 ) 1 ( - + n r
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Adjusting the discount rate to different time periods Example: Suppose your bank account pays interest monthly with an effective annual rate of 6%. What amount of interest will you earn each month? If you have no money in the bank today, how much will you need to save at the end of each month to accumulate $100,000 in 10 years?
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Annual Percentage rates (APR)
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