Video 10 Topic 2 4 Interest Rates FIN

Video 10 (Topic 2. 4): Interest Rates FIN 614: Financial Management Larry Schrenk, Instructor

Topics 1. What is an Interest Rate? 2. Types of Interest Rates 3. Conversions between Types of Interest Rates

What is an Interest Rate? Compensation for the Lending of Money Loss of the Use of an Asset Stated in Percentage Terms (Relative to the Principal) Similar to a Rental or Leasing Charge

Types of Interest Rates Holding Period Return, HPR Annual Percentage Rate, APR, NOM% Period Rates, rmonthly, rquarterly, etc. Effective (or Equivalent) Annual Rate, EAR, EFF%

Holding Period Return I Most Basic Rate Calculation Change from one point of time (t = 0) to another (t = 1): NOTE: The time from t 0 to t 1 need not be a year.

Holding Period Return II My portfolio was worth $123, 000 5 years ago and it is now worth $131, 000: REMEMBER: The earlier value always goes in the denominator!

Holding Period Return III Problem: Comparing assets with different holding periods. Which is better? 7. 8% over 7 years 10. 5% over 10 year Need a common time period Convert all rates to an annual basis ‘Annualize’ them

Annual Percentage Rate Annual Cost of Borrowing Including Fees and Transaction Costs Legal Standard–Consumer Credit Protection Act (1968) Does not Incorporate Compound Interest

APR Example Formula: What is my APR is my weekly return is 0. 25%? rweekly x m = 0. 25% x 52 = 13. 00% APR = 13. 00%

Period Rates Period Rate is the Rate over a Certain Period It is the HPR for the Period If your stock was at $110 at the end of last month and $108 at the end of this month:

Effective (or Equivalent) Annual Rate EAR Incorporates Compound Interest Accurate Calculation of Return Formula:

EAR Example If your monthly return is 2%, what is your EAR?

EAR ↔ APR EAR → APR → EAR Also, a calculator function is available.

EAR vs. APR If you get 1% return each month: If I invested $1. 00, I would have $12. 68. EAR accurately calculates the actual return. ARP underestimates your return, since it does not incorporate compound interest.

Calculator: EAR My investment portfiolo increased from $125, 500 to $275, 100 in 5 years, find my EAR? N=5 I%=0 ◄ Select I%, then [ALPHA] [ENTER] PV=-125500 PMT=0 FV=275100 P/Y=1 C/Y=1 PMT: END BEGIN I% = 17. 00%

Calculator: EAR ↔ APR 1. [ON] 2. [APPS] [ENTER] 3. CALC VARS 1: TVM Solver. . . 2: tvm_Pmt 3: tvm_I% 4: tvm_PV 5: tvm_N 6: tvm_FV 7↓npv( 4. Scroll Down to ‘B: ►Nom(’ or ‘C: ►Eff(’ ENTER NOTE: EAR = (Eff)ective Rate and APR = (Nom)inal Rate

Calculator: EAR → APR ►Nom( Function Syntax: ►Nom(EAR, m) What is the APR (Nom) based on quarterly periods, if the EAR (Eff) is 13%? ►Nom(13, 4 APR = 12. 41% ENTER

Calculator: APR→ EAR ►Eff( Function Syntax: ►Eff(APR, m) What is the EAR (Eff), if the APR (Nom) based on weekly periods is 15%? ►Eff(15, 52 EAR = 16. 16% ENTER

Video 10 (Topic 2. 4): Interest Rates FIN 614: Financial Management Larry Schrenk, Instructor