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Unformatted text preview: od interest is paid on the new principal. This contrasts simple interest where the principal is
constant throughout the investment period. To illustrate the difference between simple and compounded
interest consider the return to a bank account with principal balance of €100 and an yearly interest rate of
5%. After 5 years the balance on the bank account would be:
- €125.0 with simple interest:
€127.6 with compounded interest: €100 + 5 · 0.05 · €100 = €125.0
€100 · 1.055 = €127.6 Thus, the difference between simple and compounded interest is the interest earned on interests. This
difference is increasing over time, with the interest rate and in the number of sub-periods with interest
payments. 3.2 Present value
Present value (PV) is the value today of a future cash flow. To find the present value of a future cash flow,
Ct, the cash flow is multiplied by a discount factor:
(1) PV = discount factor Ct The discount factor (DF) is the present value of €1 future payment and is determined by the rate...
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.
- Spring '12