Question

1. Basic concepts

Finance, or financial management, requires the knowledge and precise use of the language of the field. Match the terms relating to the basic terminology and concepts of the time value of money on the left with the descriptions of the terms on the right. Read each description carefully and type the letter of the description in the Answer column next to the correct term. These are not necessarily complete definitions, but there is only one possible answer for each term.

Term

Answer

Description

Discounting

A. A 6% return that you could have earned if you had made a particular investment.

Time value of money

B. A cash flow stream that is generated by a share of preferred stock that is expected to pay dividends every quarter indefinitely.

Amortized loan

C. A concept that maintains that the owner of a cash flow will value it differently, depending on when it occurs.

Ordinary annuity

D. An interest rate that reflects the return required by a lender and paid by a borrower, expressed as a percentage of the principal borrowed.

Annual percentage rate

E. The process of determining the present value of a cash flow or series of cash flows to be received or paid in the future.

Annuity due

F. A cash flow stream that is created by an investment or loan that requires its cash flows to take place on the last day of each quarter and requires that it last for 10 years.

Perpetuity

G. A series of equal cash flows that occur at the beginning of each of the equally spaced intervals (such as daily, monthly, quarterly, and so on).

Future value

H. One of the four major time value of money terms; the amount to which an individual cash flow or series of cash payments or receipts will grow over a period of time when earning interest at a given rate of interest.

Amortization schedule

I. A type of security that is frequently used in mortgages and requires that the loan payment contain both interest and loan principal.

Opportunity cost of funds

J. A table that reports the results of the disaggregation of each payment on an amortized loan, such as a mortgage, into its interest and loan repayment components.

Time value of money calculations can be solved using a mathematical equation, a financial calculator, or a spreadsheet. Which of the following equations can be used to solve for the present value of an ordinary annuity?

a. PMT x {[(1 + r)^n – 1]/r} x (1 + r)

b. PMT/r

c. PMT x {[(1 + r)^n– 1]/r}

d. PMT x {1 – [1/(1 + r)^n]}/r

Answer 1

A. A 6% return that you could have earned if you had made a particular investment.

Opportunity cost of funds

B. A cash flow stream that is generated by a share of preferred stock that is expected to pay dividends every quarter indefinitely.

Perpetuity

C. A concept that maintains that the owner of a cash flow will value it differently, depending on when it occurs.

Time value of money

D. An interest rate that reflects the return required by a lender and paid by a borrower, expressed as a percentage of the principal borrowed.

Annual percentage rate

E. The process of determining the present value of a cash flow or series of cash flows to be received or paid in the future.

Discounting

F. A cash flow stream that is created by an investment or loan that requires its cash flows to take place on the last day of each quarter and requires that it last for 10 years.

Ordinary annuity

G. A series of equal cash flows that occur at the beginning of each of the equally spaced intervals (such as daily, monthly, quarterly, and so on).

Annuity due

H. One of the four major time value of money terms; the amount to which an individual cash flow or series of cash payments or receipts will grow over a period of time when earning interest at a given rate of interest.

Future value

I. A type of security that is frequently used in mortgages and requires that the loan payment contain both interest and loan principal.

Amortized loan

J. A table that reports the results of the disaggregation of each payment on an amortized loan, such as a mortgage, into its interest and loan repayment components.

Amortization schedule

Time value of money calculations can be solved using a mathematical equation, a financial calculator, or a spreadsheet. Which of the following equations can be used to solve for the present value of an ordinary annuity?

d. PMT x {1 – [1/(1 + r)^n]}/r