What is the essential concept in understanding compound interest?
The concept of earning interest on interest is the essential idea that must be understood in the compounding process.
What does the time value of money mean?
It depends, maybe you’ll lose your money. Time value means that if an investor is offered the choice between receiving $1 today or in the future, the proper choice is to receive $1 today.
What is present value?
Present value reflects the time value of money and is the amount that should be paid today for an investment expected to produce future income.
How does discounting relate to compounding?
Discounting is the opposite of compounding; present value is found by taking the reciprocal of the interest factor and multiplying it by the future value.
What is an annuity?
An annuity is a series of equal deposits or payments.
What is the difference between an ordinary annuity and an annuity due?
An ordinary annuity assumes payments occur at the end of a period, while an annuity due assumes payments are made at the beginning of the period.
How must one discount a series of uneven receipts to find present value?
Each cash receipt must be discounted individually then summed: PV = CF1 (1/1 + i)1 + CF2 (1/1 + i)2 + … + CFn (1/1 + i)n.
What is an internal rate of return?
The internal rate of return measures a return on investment over the entire period, expressed as a compound rate of interest.
What is the difference between a Nominal Annual Rate Compounded Monthly and the Effective Annual Rate?
The Nominal Annual Rate is the stated rate and does not represent the effective rate; the Effective Annual Rate accounts for monthly compounding.
How can a growing perpetuity model a commercial real estate building?
It assumes revenue and expenses grow at a constant rate over time, allowing valuation using the present value of a growing perpetuity.
How can a growing perpetuity model your retirement?
It estimates future spending in retirement will grow at a constant rate, allowing determination of present value to cover future expenses.
