Lectures Notes Finance first semester, Study notes of Economics

Download Lectures Notes Finance first semester and more Study notes Economics in PDF only on Docsity! Interest Rates Discount rate should reflect the actual return we could earn over that time period Effective Annual Rate (EAR) : amount of interest in the end of the year Equivalent n-Period Discount Rate = (1+r)^n - 1 Annual percentage rate (APR) : amount of interest without compounding → cannot use for discount rate (discount) Interest Rate per Compounding Period = APR / k periods / year Converting an APR to EAR : 1 + EAR = (1 + APR/k)^k Amortizing loans: you pay interest on the loan plus some part of the loan balance Computing Loan Payments : PV annuity formula to see what was paid on interest rate Nominal interest rates: quoted by banks, used for discounting cash flows Growth in purchasing power = 1 + ri = 1 + ni / 1 + inf = growth of money / growth of prices Real interest rate rr = ni - inf / 1 + inf → approx ri - inf Raise interest rates to reduce investments when there is high inflation Term structure :relation between investment term and the interest rate → yield curve (riskfree interest rates + zero-coupon yield curve) Present value of a cash flow stream using a term structure of discount rates : PV = C1 / 1 +r + …… + Cn / 1+rn → interest rates vary Note: we are discounting all of the cash flows at the same rate Interest rate Determination in very short term by federal funds rate → rate at which banks can borrow cash reserves on an overnight basis → all other on yield curve are adjusted to supply (lending) and demand (borrowing) Interest rate expectations: if expected ir goes up then long-term > short-term If expected ir fall the long-term < short-term → negative economic growth Treasury rate → 0 risk of default Risk of default: stated interest rate is maximum amount investors will receive After-tax interest rate: r - (t x r) = r (1 - t) Interest on loans tax deductible → effective after-tax interest rate = r (1 - t) Discount rate based on opportunity cost of capital → best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted