Week 1

Week 1 Ch3: .3 and .4, Ch4, Ch6: .1-.3, Ch7: .1-.4 3.3 - The Time Value of Money and Interest Rates The Time Value of Money - the difference in value between money today and money in the future The Interest Rate: Converting Cash across Time - interest rate, r, for a given period as the interest rate at which money can be borrowed or lent over that period - We refer to (1+r) as the i nterest rate factor for cash flows; it defines how we convert cash flows across time, and has units of "$ in one year/$1 today." - FV = value after 1 period
- Co = the amount invested or borrowed now - R = interest rate - PV = present value now - C1 = cash flow in one year - R = interest rate 3.4 - Valuing Cash Flows at Different Points in Time Rule 1: Comparing and Combining Values - Our first rule is that it is possible to compare or combine values only at the same point in time. This rule restates a conclusion from the last section—only cash flows in the same units can be compared or combined Rule 2: Compounding - Our second rule stipulates that to calculate a cash flow's future value, you must compound it. - - Compound interest - earning interest on both the original deposit and on the accrued interest known as compound interest - Simple interest - interest earned only on the original deposit
- Rule 3: Discounting - Our third rule stipulates that to calculate the value of a future cash flow at an earlier point in time, we must discount it. - - This process of finding the equivalent value today of a future cash flow is known as discounting
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