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88 Cards in this Set
- Front
- Back
What is the goal of financial management within a corporation.
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Maximize current stock price
Maximize shareholder wealth |
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Agency Problem
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When a corporate manager owns < 100% of the outstanding common stock.
Result: Behavior that is NOT ultimately in the best interest of the shareholder. |
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What makes managers act in shareholders best interests?
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Pos: Structure of compensation package
Neg: threat of being fired by shareholders, or a threat of hostile take over. |
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Corporate Ethics and social responsibility
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Corporate scandals increased corporate, consumer, and investor focus on ethics and social responsibility.
CSR- Corporate social responsibility. Socially responsible actions can be costly but it can still enhance the firms value. (Firms get money for doing the right thing) |
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Financial Markets
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mechanism for bringing borrowers and lenders together.
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Money Market
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short-term debt securities
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Capital Market
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equity (stock) and longer- term debt securities
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Primary Market
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original sale of securities by governments and corporations
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Secondary Market
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sale of securities after initial issue. ( The originator is not involved in secondary markets.
Ex: If IBM passes the stock on, they are not involved in the second market. It is although important to have a secondary market. The value will drop if there isn't an active secondary market. |
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What is the fundamental relationship characterized by the balance sheet?
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Assets= liabilities+ owners equity
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Liquidity
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the ability of an asset to be quickly converted to cash with little or no loss in value.
The more liquid your assets the easier it is to pay your bills. But, assets that are the most liquid are the least productive. |
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What is the most liquid asset
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Cash
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Liquidity tradeoff
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liquid assets reduce probability of financial distress, but they yield smaller returns.
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Dividend Payout ratio
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dividends paid/ net income
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retention ratio
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1- DPR
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EPS- earnings per share
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Net income/ shares outstanding
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DPS- Dividends Per Share
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Dividends paid/ shares outstanding
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EBITDA
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EBIT (earnings before interest on taxes)+ depreciation expense
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EBT
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EBIT- interest expense
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NOPAT
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EBIT- Taxes
not a line on the income statement |
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When will accounting income vs. cash flow differ?
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Recording of revenues and expenses might not match timing of cash flows.
Non cash items (depreciation expense) reduced account income but we don't actually pay it out. |
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what are the sources of cash identified on the balance sheet as?
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Decreases in assets
Increase in equity and liabilities |
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What are the uses of cash identified on the balance sheet?
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Increase in assets
decrease in equity and liabilities Ex: Pay off a loan |
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Cash flow identity
Cash flow from assets= |
CF to creditors+ CF to stockholders
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What does the cash flow from assets tell us?
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How much cash is needed above and beyond what is needed to operate a company.
Need 2 balance sheets and and income statement |
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Cash flow from assets=
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Operating CF (OCF) - net capital spending- change in NWC
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net working capital=
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current assets- current liabilities
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OCF=
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find this first
EBIT + depreciation - taxes |
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Net capital spending=
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end net fixed assets- beg. net fixed assets + depr. expense
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Change in NWC=
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end NWC- beg. NWC
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Cash flow to creditors/ bondholders=
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interest paid- net new borrowing
Net new borrowing= change in long term debt= this years- last years |
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Cash flow to stockholders=
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dividends paid- net new equity raised
Net new equity raised= change in common stock and paid- in capital= this years equity- last years equity |
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Sarbanes- Oxley Act of 2002
What is it? Who promoted it? What are some provisions? Is it working? |
Public company accounting reform and investor protection act.
enron and other scandals - CEO's and CFO's must verify financial statements -no personal loans to company excess - independent auditing committee -rotate lead auditing firm at least every 5 years. |
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liquidity ratios
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Current ratio
quick ratio cash ratio |
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current ratio
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CA/CL
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Quick ratio
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(CA - INV)/ CL
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Leverage ratios
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total debt ratio
debt- equity ratio equity multiplier times interest earned ratio cash coverage long- term debt ration |
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Total debt ratio
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D/A
total liability/total assets |
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debt- equity ratio
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D/E
total liability/ owners equity |
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equity multiplier
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= Ttl assets / Ttl owners' equity
A/E= 1 + D/E total assets/ owners equity= 1 + total liability + total liability/owners equity |
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long-term debt ratio=
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long term debt/ total assets
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times interest earned ratio
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EBIT/ interest expense
The higher this is the more solvent we are |
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cash coverage
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EBIT+ depreciation expense/ interest expense
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days sales outstanding
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AR/(Sales/365)
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fixed assets turnover
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sales/ net fixed assets
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total assets turnover
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sales/ assets
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capital intensity ratio
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assets/ sales
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profitability ratios
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profit margin
return on assets (ROA) Return on Equity (ROE) |
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Profit margin
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net income/ sales
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return on assets (ROA)
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net income/ assets
or (NI/Sales) x (Sales/Assets) or Profit Margin x Ttl Asset Turnover |
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return on equity (ROE)
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net income/ total owners equity
or (NI/Sales) x (Sales/Assets) x (Assets/Equity) or Profit Margin x Ttl Asset Turnover x Equity Multiplier |
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What are some problems regarding profitability ratios
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numerator (NI) can be misleading
ROE denominator (equity) can be altered by changing capital structure |
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what is the alternative profitability measure
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Basic earning power: EBIT/ Assets
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market value ratios
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price/earnings ratio
market/book ratio |
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price/ cash flow ratio
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Price per share / Cash flow per share
Cash flow per share = (NI + Dep)/Shares outstanding |
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price/ sales ratio
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Price per share / Sales per share
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ROA
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NI/A= profit margin X total asset turnover
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ROE
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NI/Equity= Profit margin X Ttl Asset Turnover X equity multiplier
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How do we choose benchmark firms
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identify competitors (individual firms or groups of firms in the same industry)
SIC codes: standard industry classification (4- digits) NAICS: North American Industry classification system ( 5-6 digits) use various databases to find firms with matching industry codes other sources provide industry wide ratios, broken down by industry code or description |
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what are the standardized financial statements?
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Common size statements
common base year statements They detect trends; compare across firms. |
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common size statements
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balance sheet: express amounts as % of assets
Income statement: express amounts as % of sales |
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common base year statements
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select your base year, express all amounts as % of base year values.
This helps you look at trends. It is not in place of ratios, it is just a compliment. |
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To evaluate a firms financial position
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break down cash flows OFC from assets, etc.
common base year statements/ trend analysis common size statements/ benchmark comparisons ratios--> evaluate over time and compare to benchmarks careful choice of benchmarks is crucial to meaningful analysis. |
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What is the most common forecasting approach?
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Percentage of Sales Approach
(What we used for Binky and Dora) |
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What are the two types of forecasting for special case benchmarks?
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Internal growth rate
sustainable growth rate |
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Internal growth rate
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maximize growth rate "g" in assets, and sales. A firm can achieve with no new external financing.
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What does the internal growth rate assume?
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Targeted ratios of DPR, NI/S, A/S
no new stock or debt issues NI/S=> as sales go up cost goes up and NI stays constant A/S=> total asset turnover |
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sustainable growth rate
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max growth rate "g" in assets with NO new external equity financing
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what does the sustainable growth rate assume?
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Targeted rations of DPR, NI/S, A/S, D/E
no new stock issues Sustainable growth rate should be higher than internal growth rate. |
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Future value and compounding
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The amount of money on investment will be worth at a given point in the future at a given interest rate.
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What are the forecasting issues?
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Lumpy assets- not every asset can be added in whatever increment you want.
excess capacity- assets will be forecasted to increase at a smaller percentage than the sales increase, or perhaps not at all. |
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What are the trends in forecasting and planning?
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Use the rolling forecast. Forecast rolls several months or quarters into the future with each new update.
use 12 months or 4 quarter horizons able to adapt well in changing conditions |
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Forecasting
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Frequency of updates of forecasts: about 1/3 each update.
-1X/ quarter -1X/ monthly -1X/ year or as events warrant |
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What are the perceived benefits of Better forecasts?
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1. avoid performance surprises
2. managing working capital and profitability 3. Not so much to company regulations |
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Time value of money
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a dollar in hand today is worth more than a dollar tomorrow.
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Simple interest
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You only earn investment on original principal
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compound interest
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earn interest on the principal and the interest.
we always assume compound interest |
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Future value of a Lump Sum equation
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FV= PV( 1+i) ^n
i= interest rate per period FV= future value PV= present value (initial lump- sum investment) n= number of periods |
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annuity
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finite level stream of cash flows
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ordinary annuity
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also called "deferred" annuity. Cash flows occur at the END of each period.
Ex: You make end of month payments. |
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Annuity due
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Cash flows occur at the beginning of each period.
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Present value of annuity equation
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PVA=pmt[1-1/(1+i)^n/i
assumes end of period payments |
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PVA
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The PVA is 1 CF- period BEFORE the 1st pmt.
The present value of each payment should be getting smaller. |
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Perpetuities
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series of level cash flows forever
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Present value of a perpetuity
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pmt/i
*formula assumes end-of-period Cash Flows. |
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Effective annual rate
EAR= |
Compounds
(1+q/m)^m -1 where: q= quoted rate per yer m= number of compounding periods per year |
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How do you find effective rates
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= (1+ APR per compounding period) ^ #compounding periods in the STP-1
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what effective IR do you use for annuities?
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Interest rate must correspond to timing of cash flows
Ex: annual cash flows=> use EAR |