Question

Write a short journal that addresses the following concepts: compounding versus discounting; ordinary versus annuity due; perpetuity; uneven cash flow; semiannual or other compounding periods and the impact on compounding/discounting; nominal interest rate versus effective annual rate; and amortization.

Answer 1

Compounding is related to the future value whereas discounting will be related to the present value and compounding will be done in order to find the value of a future sum of payment at future date and discounting will be done in order to find the present value of a future stream of payments.

Ordinary annuity is paid at the end of the year where as annuity due is paid at the beginning of the year and an ordinary annuity will be having a higher amount of interest component associated with it.

Perpetuity is similar amount of cash flows which will be continuing always and uneven cash flows are those cash flows which will be not regular in nature. There will be various cash inflows and cash outflows in uneven cash flows.

Semi annual compounding will mean when compounding will be done 2 times a year after 6 months and quarterly compounding will be done at four times a year where as early compounding will be done once a year and it will mean that it will be having a different effect on the discounting and compounding rate.

Nominal interest rate will be including the effect of inflation and real interest rate will exclude the inflation. Amortization will be leading to payments of debt and it will include both interest and principal payment in installments.