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Class 2 Jan 9th Before

# ‘interest’ and ‘interest rates’ i interest i

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Unformatted text preview: ‘Interest’ and ‘Interest Rates’ I Interest I is the price someone who borrows money (borrower, debtor) pays the lender (creditor) for the use of the borrowed money. – I Usually expressed as an annual percentage of the outstanding balance (‘principal outstanding’): => Interest rate r I Interest rate charged depends on: – We distinguish between simple and compound interest. 9 Visual Aid: The Timeline I A timeline is a linear representation of the timing of potential cash flows. I Drawing a timeline of the cash flows lets you visualize a financial problem that involves cash outflows and inflows at different points in time. 10 Visual Aid: The Timeline I A timeline is a linear representation of the timing of potential cash flows. I Drawing a timeline of the cash flows lets you visualize a financial problem that involves cash outflows and inflows at different points in time. 11 Time Lines 12 Cash Flows and The Timeline I One can differentiate between two types of cash flows: – Inflows are positive cash flows. – Outflows are negative cash flows, which are indicated with a ‘–’ (minus) sign. – Example: You borrow \$10,000 from a friend. You repay him in two installments of \$5,500 at the end of each of the next two years. – Your cash flows look like this: 13 Simple Interest I Interest that is paid only on the amount originally invested but not on any interest that accrues subsequently. I Interest payments are given by I =r*P each period, where r is the simple rate of interest I Over n periods, the original amount invested grows to I Example: – Firm borrows \$100 at 5% simple interest due at the end of 4 years....
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‘Interest’ and ‘Interest Rates’ I Interest I is the...

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