Class 2

Today's Comic

After today’s lecture, and after working the homework problems, the student should be able to

Determine the amount of money required to be invested to acquire a given amount of money at some time in the future.
Know the meaning of, and be able to solve economic problems involving equivalence.
Be able to use the rule of 72 in economics problems.
Be able to solve problems in which sub-compounding periods are involved.
Be able to solve problems in which continuous compounding is involved.
Utilize and solve economic equivalence problems using any of the standard cash flow series equations.

Emphasize drawing of cash flow diagrams

Emphasize EQUIVALENCE

Emphasize that when a bank says 6% interest, they mean 6% nominal per year, not 6% per month, not 6% per day, not anything else!

Derive Economic Formulas <–Print out this page and bring it to class with you.

Rule of 72 – 1% for 72 years = 2.047, 2% for 36 years = 2.039, 4% for 18 years = 2.026, 8% for 9 years = 1.999, etc.

Nominal and effective interest rate for sub-compounding periods

$1 at 12%/year (nominal) compounded once a year: F = $1(1+0.12)^1 = $1.12, so itrue = ($1.12-$1.00)/$1.00 which is a true rate of 0.12 = 12% /year
$1 at 12%/year (nominal) compounded every 6 months: F = $1(1+0.12/2)^2 = $1.1236 which is a true rate of 12.36% /year
$1 at 12%/year (nominal) compounded monthly: F = $1(1+ 0.12/12)^12 = $1.126825 which is a true rate of 12.6825% /year
$1 at 12%/year (nominal) compounded secondly: F = $1(1+ 0.12/(365*24*60*60))^(365*24*60*60) = $1.1273129 which is a true rate of 12.73129% /year

Show economics shorthand conventions: F = P[ 1 + i ] n = P [ F / P , i , n ]

Show where materials available for use on the exam can be found. <–Print this out and bring it to class with you.