Getting started here. Quiz next week, so I need to spend some time this week doing homework. Still dealing with Time Value of Money.The present value of money received very far in the future is very low.
A perpetuity is an annuity that never ends. The payment would be the same every period, forever. The present value of a perpetuity is simply the payment amount divided by the interest rate.
The nominal interest rate is the annual interest rate, ignoring compounding effects.
The Effective Annual Rate is the annual rate of interest being earned, accounting for compounding. Effectively, the EAR will be higher if interest is compounded more frequently than once a year.
Chapter 6:Â Interest Rates
Four factors affect the level of interest rates.
- Production opportunities
- Time Preferences for Consumption
- Risk
- Expected Inflation
Nominal vs. Real Interest rates.
r is the nominal interest rate.
r* is the real, risk-free rate of interest, like a T-Bill rate if inflation was 0%. Typically ranges from 1% to 4% a year.
r[RF] is the rate of interest on Treasury securities. The difference between it and r* is the inflation rate.