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Related Flashcards
Cards In This Set
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Describe how you can use the Rule of 72 to make financial planning decisions.
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The Rule of 72 allows us to figure out the amount of time it'll take for a sum of money to double, given that you know the annual interest rate. It's important to know this because it can help the spender visualize and reorganize their 1, 5, 10, 20, or 50 year financial goals by providing a simple, fast method of examining one's own investment. So if an investment grows at 9% per year, according to this rule, it should take 72/9= 8 years for that sum to double.
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What two factors most affect how much people need to save to achieve their financial goals?
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Time and interest rate
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Why might an investor require a greater expected return for an investment of longer maturity? Do you feel you can forecast inflation 2 years from now with greater accuracy than inflation in 20 years?
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An investment of longer maturity may have higher interest rates; it's more risky, but over time, the ups and downs may even out. Plus the compounding interest will just continue to grow and grow. (There's greater risk for longer investments). I feel like it's easier to predict inflation 20 years from now just because in 2 years, a lot can happen. But in 20...we can easily take into account trends in the past into our hypothesis.
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Why is it necessary to use negative present value when solving for N (the number of payments) or I/Y (the rate of return)? Similarly, why does the answer have a negative sign if positive payments were used when solving for a ftuure value on a calculator?
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It's negative bcause the money is leaving my possession into the bank. When I take the money out of the bank (i.e. future value), the sign is positive.
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A couple just got married and received $30K in cash. If they place half of this money in a fixed rate investment earning 12% compounded annually, in 25 years, they'll have over 255,000. Would the fv be larger or smaller if the copounding period was six months?
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With shorter compounding periods, they'll earn more. This is because interest is earned on interest more frequently as the length of the compounding period declines.
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You and 11 coworkers just won $12 million. Should you op to receive the share over 20 years (with a 6% return on funds), or request the up-front cash option? Why?
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Uhhh...I need help. I know that you should do it over 20 years...but that's about it.
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Time value of money
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The concept that a dollar received today is more than a dollar received in the future and, therefore, comparisons between amounts in different time periods cannot be made without adjustments to their values.
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Compound interest
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The effective of earning interest on interest, resulting from the reinvestment of interested paid on an investment's principal.
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Principal
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The face value of the deposit or debt instrument.
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Present value
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The current value, that is, the value in today's dollars of a future sum of money
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Annual interest rate
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The rate charged or paid for the use of money on an annual basis
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Future value
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The value of an investment at some future point in time
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Reinvesting
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Taking money that you have earned on an investment and plowing it back into that investment
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Compounded annually
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With annual compounding, the interest is received at the end of each year and then added tot he original investment. Then, at the end of the second year, interest is earned on this new sum.
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Discount rate
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The interest rate used to bring future dollars back to the present (i.e. if we expect to receive a sum of money in 10 years and want to know what it would buy in today's dollars, we would discount that future sum of money back to the present at the anticipated inflation rate.)
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