effective annual rate (EAR)
actual amount of interest earned in one year
(1+r)^N - 1
Formula APR -> EAR
1 + EAR = (1 + APR/k)^k
Real interest rate
The real interest rate indicates the rate of growth of one's purchasing power after adjusting for inflation
r(real) = (r - i) / (1 + i)
approx r - i
Higher interest rates tend to _____ the NPV of typical investment projects.
The Fed _____ interest rates to moderate investment and combat inflation and _____ interest rates to stimulate investment and economic growth.
reduce
raises
lowers
yield curve
The graph plotting interest rates as a function of the horizon. Steeper: long term rates going up. Inverted: long term rates going down.
The shape of the yield curve tends to vary with investors' expectations of future economic growth and interest rates. It tends to be ______ prior to recessions and to be _____coming out of a recession
inverted
steep
opportunity cost of capital
the expected return available in the market on other investments of comparable risk and term
the effective after-tax interest rate of a tax deductable loan
r * (1-tax rate)
federal funds rate
very short-term interest rates determined by Fed. Rate at which banks can borrow cash reserves overnight. All other rates on yield curve are set in the market.
If interest rates are expected to ______, L-T interest rates will tend to be ______ than S-T to attract _________.
rise / higher / investors.
fall / lower / borrowers
term structure
The relationship between investment term and interest rate