Question

Please explain the following terms:

Number of periods

Multiple cash flows

Compounding periods

EAR

Perpetuity

Growing perpetuity

Annuity

Answer 1

number of periods : Is the amount of time it is required for a single cash flow, to reach a certain amount of money in the future.

FV = pV ( 1+ R)^N

Where, n = number of periods.

Multiple cash flows :if the multiple cash flows are fixed an earn a particular rate of interest every year it is called an annuity.

The Fv of multiple cash flows is the sum of the individual Fv of cash flows.

The compounding periods is the lenght of time from one interest payment to the next. It is either compounded annually, semi- annually or quarterly.

EAR : Is the interest rate that an investor can earn in a year after it is compounded over a given period of time. It is helpful as it provides us with the calculation of the true interest on a loan .

formula for EAR IS :

EAR = [( 1 + i/n)^n ]- 1

Perpetuity: is a constant stream of cash flows that are identical and have no end.

Present value of perpetuity = D/r

d= dividend or coupon per year

r = discount rate

Growing perpetuity : is a series of periodic cash flows that is growing at a periodic rate and are received for an infinite amount of time.

PV of growing perpetuity is = D1/ Re - g

Annuity is a series of cash flows at is paid at regular intervals.

Examples are ; monthly deposits at savings account, monthly home mortgage payments.