Money, Time Value, and Interest Rates
Core time-value concepts, compounding shortcuts, and the bond yield family tested on the SIE.
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Questions Covered in This Set
10 cards to master
Future value formula
FV = PV × (1 + r)^n — money grows forward as interest earns interest (compounding).
Present value formula
PV = FV ÷ (1 + r)^n — future cash flows discounted back to today at the discount rate r.
What determines a security's price?
Price = the present value of its expected future cash flows (coupons and principal for bonds; dividends/earnings for stock). Higher discount rate = lower price.
Relationship between interest rates and bond prices
They move in opposite directions. If rates rise, existing bonds with lower coupons fall in price until their yield is competitive; if rates fall, they trade at a premium.
Rule of 72
Divide 72 by the interest rate to estimate years to double. At 8% ≈ 9 years; at 6% ≈ 12 years.
Nominal rate vs. effective annual yield (6% semiannual)
6% compounded semiannually is 3% twice: 1.03² − 1 = 6.09% effective annual yield, slightly more than the 6% stated rate.
Real vs. nominal return
Real return ≈ nominal return − inflation. Earning 6% with 3% inflation grows purchasing power about 3%; inflation risk = purchasing power risk.
Current yield
Annual coupon ÷ current market price. A $50 coupon on an $860 bond = 5.81%.
Yield to maturity (YTM) vs. yield to call (YTC)
YTM = total annualized return if held to maturity, including discount/premium gain or loss. YTC = same calculation assuming the issuer calls the bond early.
Yield ordering for discount vs. premium bonds
Discount = ascending: Nominal < Current < YTM < YTC. Premium = descending: YTC < YTM < Current < Nominal. At par all equal the coupon.
