FIN 300 EXAM #2 Study Guide PDF

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Study Guide for FIN 300 Exam #2

Chapter 5 (The Time Value of Money) Problems similar to the homework problems we reviewed in class. Time value of money –concept that a sum of money has greater value now than it will in the future due to its earnings potential. -

Thus, a dollar today is worth more than a dollar received in the future. Another way

Net present value – The present value is the value today of a future cash flow. Computing the present value involves discounting future cash flows back to the present at an appropriate discount rate. The process of discounting cash flows adjusts the cash flows for the time value of money. Computationally, the present value factor is the reciprocal of the future value factor, or 1/(1 + i). Discounting – That is, present value calculations bringing a future amount back to the present (determining the current value (or present value) of a future cash flow) -

The process of calculating the present value is called discounting, and the interest rate i is known as the discount rate

Future value – what the investment will be worth after earning interest for one or more time period -

For future value calculations, the higher the interest rate, the faster the investment will grow

Single Period Investment - Future value at the end of Year 1 = Principal + Interest earned -

you place $100 in a bank savings account that pays interest at 10 percent a year. = 100 (100 x 0.10) = 110

Two-Period Investment – 100 x (1+0.10) ^2 = 100 x (1.10) = 121 -

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you decide to leave this new principal amount (FV1) of $110 in the bank for another year earning 10 percent interest. How much money would you have at the end of the second year (FV2)? FV (2) = FV (1) x (1+i) or P (1+i)^2

Compounding – Compound interest includes not only simple interest but also interest earned on the reinvestment of previously earned interest, the so-called interest earned on interest. Principal – the money that you originally agreed to pay back

Simple interest – calculating the interest charge on a loan -

Simple interest = (P)*(I)*(N) P = principle I = interest rate N = number of days between payments 100,000, one year, 5% interest rate = (100,000) (1)(0.05)

Compound interest - when interest gets added to the principal amount invested or borrowed, and then the interest rate applies to the new (larger) principal -

Compound Interest = P * (1+r) ^t – P P = principle R = annual interest rate T = number of years interest is applied

The Rule of 72 – Definition and know the formula. -

used to determine the approximate amount of time it takes to double the value of an investment the rule is fairly accurate for interest rates between 5 and 20 percent. Outside these limits, the rule is not very accurate. TDM = 72/I (I is the rate of return expressed as a percentage)

Chapter 8 (Bond Valuation) Fixed-income securities – Debt instruments, where the interest income paid to investors is fixed for the life of the contract. Coupon Payments – The dollar amount of interest paid to an investor. -

The amount is calculated by multiplying the interest of the bond by its face value

Face value or Par Value – The facevalue, or parvalue, for most corporate bonds is $1,000 Coupon Rate – is the nominal yield paid by a fixed-income security. It is the annual coupon payments paid by the issuer relative to the bond's face or par value Vanilla Bonds – These bonds have coupon payments that are fixed for the life of the bond, and at maturity, the principal is paid, and the bonds are retired. -

Vanilla bonds have no unusual features. Payments are usually made annually or semiannually.

Par value bonds - the amount of money that bond issuers promise to be repaid bondholders at a future date.

Premium bonds - the interest paid is decided by a monthly prize draw. Discount bonds - a bond that is issued for less than its par—or face—value

Bonds Notes (Posted on Canvas and Discussed in Class) 

Yields (Here is your Math) – Nominal yield, Current yield.

Nominal Yield - calculated by dividing all the annual interest payments by the face, or par, value of the bond Current Yield - current yield is equal to the annual interest earned divided by the current price of the bond. Suppose a bond has a current price of $4,000 and a coupon of $300. -

Divide $300 by $4,000, which equals 0.075. Multiply 0.075 by 100 to state the current yield as 7.5 perc...