UCLA ECON 103 - Chap003 (1) (8 pages)

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Chap003 (1)



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Chap003 (1)

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Pages:
8
School:
University of California, Los Angeles
Course:
Econ 103 - Introduction to Econometrics

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Chapter 03 Mortgage Loan Foundations The Time Value of Money Solutions to Questions Chapter 3 Mortgage Loan Foundations The Time Value of Money Question 3 1 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 and is the cornerstone of all financial tables and concepts in the mathematics of finance Question 3 2 How are the interest factors IFs Exhibit 3 3 developed How may financial calculators be used to calculate IFs in Exhibit 3 3 Computed from the general formula for compounding for monthly compounding for various combinations of i and years FV PV x 1 i n Calculators can be used by entering 1 for PV the desired values for n and i and solving for FV Question 3 3 What general rule can be developed concerning maximum values and compounding intervals within a year What is an equivalent annual yield Whenever the nominal annual interest rates offered on two investments are equal the investment with the more frequent compounding interval within the year will always result in a higher effective annual yield An equivalent annual yield is a single annualized discount rate that captures the effects of compounding and if applicable interest rate changes Question 3 4 What does the time value of money TVM mean Time value simply means that if an investor is offered the choice between receiving 1 today or receiving 1 in the future the proper choice will always be to receive the 1 today because that 1 can be invested in some opportunity that will earn interest Present value introduces the problem of knowing the future cash receipts for an investment and trying to determine how much should be paid for the investment at present When determining how much should be paid today for an investment that is expected to produce income in the future we must apply an adjustment called discounting to income received in the future to reflect the time value of money



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