FINANCE Lecture Notes - Lecture 3: Annual Percentage Rate, Effective Interest Rate, Interest
Document Summary
Finance chapter 5: interest rates: interest rate quotes & adjustments, when evaluating cash flows, the interest rate must be transformed into discount rate that matches the time period of cash flows. Effective annual rate (ear): indicates actual amount of interest that will be earned at end of year: raising the interest rate factor (1+r) to appropriate power/fractional power adjusts it to time period. Annual percentage rate (apr): indicates the amount of simple interest earned in one year. Simple interest: amount of interest without the effect of compounding: apr is less than actual amount of interest that will be earned because does not include compounding. Thus: cannot be used as discount rate & must be converted to ear. Rules for working with apr: determine the actual interest rate per compounding period or convert an apr to ear, compute appropriate discount rate by compounding. Amortizing loans: loans on which each month you pay interest + some part of loan balance.
