# What is an opportunity cost rate

Principles of finance I

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4-1

Thus is an annuity which has payments experienced when a period ends.

1. PV stands for present value. It is a single or a series of cash flows which should be expected at a later date.
• ‘i’ is the interest rate experienced yearly.
• INT is the total sum of interest earned each time in dollars.
• FVn is the future value of one payment after a number ‘n’ periods.
• PVAn is the annuity’s present value, where n is the amount r of payments of the annuity.
• FVAn is the future value of an annuity, where n is the annuity’s amount of payments.
• PMT is the dollar amount of a standardized fixed annuity or cash flow.
• ‘m’ is the amount of compounding periods per year in the EAR equation.
• iNom is the standardized rate set by institutions of finance.
2. The opportunity cost rate is the best rate of return available when the given amount of money is put into an alternate investment of similar risk.
3. An annuity is a series of payments of a fixed amount for a given number of periods. A lump sum payment, is a single payment occurring now
4. ordinary annuity

It is a series of fixed payments that are made at regular basis that continue for a very long time.

1. Perpetuity
2. It is the transfer of money from one party or company to another.

1. Outflow
2. The transfer of money from one company to another for the purposes of investments or financing the company.

1. Inflow
2. This is the method used to find the future value of the current investment.

1. Terminal value
• Compounding.
2. The process of making the current amount into the future value.

1. Discounting
2. This is when an interest of a current investment is compounded on a yearly basis.

1. annual compounding
2. This is a compounding done in one year but the interests are usually credited after a certain period of time.

1. Semiannual compounding
2. This is compounding where interests are credited every three months.

1. Quarterly compounding
2. This is a compounding where the interests are credited after every month.

1. Monthly compounding
2. This is an interest rate that is usually compounded and pays for an investment or loan on a yearly basis.

1. Effective annual rate
2. This is an interest rate that is usually taken before prices of products or services start rising into the account.

1. Nominal interest rate
2. This is an interest rate taken to charge for a loan taken over the agreed period of time.

1. Periodic rate
2. This is a table that consists of loan payments where it shows the principal amount and the interest rates till the loan gets paid off.

1. Amortization schedule
2. Principal is the amount that remains after paying up a loan.

1. Principal versus interest
2. Interest is the amount paid to the company that gave out loan for an investment.

This is a loan which shows very organized payment with the principal and interest of the loan payment.

1. Amortized loan
2. 4-2

An Opportunity cost rate is the rate that an investor could have gotten in return from an investment with the same kind of risk.

An opportunity cost is the difference in return between an investment that has chosen for investment and one that has given up willingly.

Opportunity cost rate is usually used as an interest rate in order to find the present value of future capital flow. When calculating the present value, the future value is usually divided by (1 + r) annually.

4-3

The statement is true. The annuity is a continuation of fixed payment made at interval times over a fixed period of time. The money for the payment should always be fixed in order for it to qualify to be annuity.

4-4

The statement is true because annual growth rate is 7.18%.

When calculated it becomes;

FV= PV (1+r)n

2 = 1 (1+r)10

(1+r)10 = 2

(1 + r) = 2(1/10)

(1 + r) = 2(0.1)

(1 + r) = 1.0718

r = 1.0718 – 1

r = 0.0718 = 7.18%

4-5

I would prefer a savings account which pays 5% interest and is daily compounded than one which is semiannually compounded because the compounded daily has a higher an interest earned on interest.

5.1

It is a legal contract between an investor and a borrower concerning the terms and payment of the loan.

1. Bond
2. It is a type of bond that has a credit risk.

1. Corporate bond
2. This is a bond that are given by the state or the local government.

1. Municipal bond
2. This is a bond usually given by a different government or corporation.

1. Foreign bond
2. It is the total money that should be paid at the maturity level.

1. Par Value
2. It is the due date of any debt and should be repaid.

1. Maturity date
2. It is the payment of interest that is received when a bond is issued and after it has matured.

1. Coupon payment
2. This is the interest paid yearly at a percentage to the bond or insurer according to the contract.

1. Coupon interest rate
2. It is a bond that goes at a discounted amount and does not pay interest at a specific period.

1. zero coupon bonds
2. It is a provision that allows the investor to redeem or repurchase or retire the bond.

1. Call provision
2. This is the money kept aside for the payment of a debt period of time.

1. Sinking fund
2. This is a type of bond that can be converted into several shares by the holder.

1. Convertible bond
2. A bond that is experienced when the interest rate is below the coupon rate and also sells above its par value.

2. A bond that sells for cheaper.

1. Discount bond
2. This is the rate of return that is acquired on a bond if it reaches maturity.

1. Yield to Maturity
2. This is the rate of return that is acquired on the bond when called before date it is supposed to mature.

1. Yield to call
2. It is the formal agreement between the holders of the bond and the issuer.

1. Indenture
2. It is an unsecured bond which does not have a security collateral.

1. debenture
2. A bond having a claim on assets only after the senior debt has been paid off in the event of liquidation

1. subordinated debentures
2. bonds rated triple B or higher; very secure bonds

2. 

This is the period of time an investor plans to hold a specific and ideal investment.

1. investment horizon
2. The probability that increase in interest rates will occur can lead to the value of the bond to drop.

1. Interest Rate Risk
2. 5.2

Short-term bond prices are less sensitive than long-term bond prices to interest rate changes because funds invested in short-term bonds can be reinvested at the new interest rate sooner than funds tied up in long-term bonds.

5.3

The bond’s price will fall and its YTM rises when there is a rise in interest rate. If the bond’s maturity date is long term, its YTM will be reflected at long-term rates. The prices of the bond will be experienced at a later date by a difference in interest rates if it has been experiencing long time and maturing shortly. The YTM increases only for buyers who want to buy the bond after the interest rates have been altered. It is not available for the buyers who want to buy before the interest rates were altered.. If the bond is bought and is experienced at maturity, the YTM will not be altered by the bondholders, regardless of what happens to interest rates.

5-4

If there is a decrease in interest rate in the market, the value of callable bonds will be lower than the regular bond. This is because the issuer of bonds can decide to repurchase the bond regardless of the timing and when there is a decline in interest rates, they find it convenient to repurchase the bonds at very high interest rates while giving out new bonds with low market interest rate.

5-5

The corporation makes payments on a yearly basis to the trustee. The trustee then invests what he or she gets into securities and uses the total amount to retire the bond when it is at a maturity date.

The trustee uses the yearly payments to retire a portion of the issue each year, either calling a given percentage of the issue by a lottery and paying a specified price per bond or buying bonds on the open market, whichever is cheaper.

Reference

# Financial Management Theory in the Public Sectorby Aman Khan, W. Bartley Hildreth

The Business Model: Recent Developments and Future Research by C Zott, R Amit, L Massa
Journal of Management

An introduction to the bond markets  by Patrick J. Brown. Chichester, England ; Hoboken, NJ