FM Interest Rate Theory Flashcards

Which of the following correctly describes a varying force of interest δ(t)?

Answer: The accumulated value is exp(∫₀ᵗ δ(s) ds)

With a time-varying force of interest, the accumulation factor is the exponential of the integral of δ(s) over [0, t].

For a continuously varying interest rate, the present value factor v(t) is:

Answer: exp(−∫₀ᵗ δ(s) ds)

The present value factor is the reciprocal of the accumulation factor: v(t) = exp(−∫₀ᵗ δ(s) ds).

On the FM exam, what does 'yield rate' of an investment mean?

Answer: The interest rate at which the PV of cash inflows equals the PV of cash outflows

The yield rate (internal rate of return) is the rate i such that PV of inflows equals PV of outflows at that rate.

The equation of value principle states that for a financial transaction, at any comparison date:

Answer: PV of money received = PV of money paid

The equation of value requires that at any focal date, the accumulated or discounted values of all receipts equal all payments.

The net present value (NPV) of a project is positive when:

Answer: The yield rate exceeds the required rate of return

NPV > 0 when the project's IRR (yield rate) is greater than the investor's required (hurdle) rate of return.

If an annuity pays $500 at the end of each month for 5 years at a nominal rate of 6% compounded monthly, the present value is calculated using i_monthly =

Answer: 0.06 / 12 = 0.005

For a nominal rate of 6% compounded monthly, the effective monthly rate is 0.06/12 = 0.005 = 0.5%.