Announcements1. Vocabulary Self Awareness is due today. I will

receive them electronically or hard copy (paper).2. Quiz on Friday. 3. I want to get my web site up and running but I

need a referral to hire somebody. HELP.4. Readings for Monday Oct 10th 5. Hand out Quiz Review Questions6. Homework (take-up):

Homework Question 1How much does a front line Walmart employee

earn in 1 year?Put their income in perspective to the norm / “standard of living” in Changchun and again for all of China.

How much does it cost to rent an apartment?What is the cost of the following necessities for a

family of 3: shelter; food; transportation; education; medicine; furniture; bedding…

Homework Question 2

Homework: You have $100 to invest. Which will bring you more profit, investing it at 10% daily or annually.

a) 10% dailyb) 10% annually

Refer to MS Excel file: A FIN Lesson 4 compounding daily vs annual

This same example will be discussed again, later in this lesson or the next lesson.

How Simple Interest is Computed

Simple InterestAmount in savings x annual interest rate x time

period equals the interest.

$100 x 5% x 1 year OR 100 x .05 x 1 = $5.00

After one year you have $100 in principal plus $5.00 in interest for a total of$105 at the end of year 1.

Discount RateDiscount Rate is the rate of return that is applied

to an investment whose future value is known.

For example, if you are promised $1,000 in one year, at a 10% rate of return, you will need to invest $909.09 today.

Therefore, $909.09 is the value of $1,000 discounted at 10% for one year.

This is an example of a Discount Bond, which pays no interest during its life. The interest is built into the final payment.

If you did not know the rate of return and wanted to calculate it, to make an educated investment decision, you would use the following formula.

Rate of Return = (principal + interest) – principal principal

= $1,000 – 909.09 = 90.91 = .1 = 10% 909.09 909.09

Present Value

• The current value for a future amount based on a certain interest rate and a certain time period.

• Present value calculations are also called discounting.

• The present value of the amount you want in the future will always be less than the future amount.

• Present value can be computed for a single amount or for a series of deposits.

Future Value• Future value is the amount to which current

savings will increase based on a certain interest rate and a certain time period.

• Future value is also called compounding - earning interest on previously earned interest.

• Future value can be computed for a single amount or for a series of deposits.

Future Value continuedThe Future Value is computed when you knowa) The amount you have to investb) The % rate of the investmentc) The length of timeThe future value shows you the final compounded

value.

$100; 10%; 1 year; compounded annually = $110$100; 10%; 6 months; compounded semi-annually= $105

Time Value of Money• Increases in an amount of money

as a result of interest earned.–Saving today means more money

tomorrow. Spending means lost principal and lost interest.

• Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile.

Time Value of Money considers Compounding

Compounding gives a return on your original investment plus a return on previous returns.

(interest earned on interest)

What annual rate compounds $100 to $120 in two years? Is it 10% ? No.

Answer = 9.5445%

Year 1 $100 x 9.5445% = $9.545Year 2 $109.545 x 9.5445% = $10.456100 + 9.545 + 10.456 = 120Value of money after 2 years = $120

We call the $120 the future value.

If the rate was 10%, the value would be $121 in two years.

Think of these investments as 2 investments, each being 1 year in duration.

Year 1 $100 x 10% =$10Year 2 $110 x 10% = $11Value of money after 2 years is $121

It is important to know the difference because when borrowing and paying interest, compounding increases the total interest paid.

Present Value vs. Future ValueExample 12011: A loaf of bread = 15 RMB 2020: A loaf of bread = more than 15 RMB (inflation) The future value of a loaf of bread is more than

15RMB

Example 2100 RMB (Money in the mattress)100 RMB (invested and earning 5%)Which one can purchase more in 2020?

APR versus EAR

What is the risk of not knowing the difference between the APR (Annual Percentage Rate) and the EAR (Effective Annual Rate)?

When you are borrowing, a lender will prefer to tell you the APR (Annual Percentage Rate) rather than the EAR (Effective Annual Rate) because the APR makes it appear that you will be paying less overall interest on money you have borrowed. The APR is a conventional method of quoting interest rates that ignore the compounding effect completely.

Some, but not all, countries require that the EAR be disclosed. Canada requires disclosure of the Effective Annual Rate.

The APR (Annual Percentage Rate) FORMULA ignores compounding

APR = the periodic interest rate is multiplied by the number of periods in one year.

Page 21 in the textbook

Note: In financial calculations, subscript indicates the nature of the variable, not a calculation.

Example: APR = 1.25 % interest per month MULTIPLIED BY 12 months = 15%

(0.0125 X 12) = 15%

FORMULA for the EAR (Effective Annual Rate) which accounts for compounding

Page 22 in the textbook

EAR = (1 + the stated interest rate K, DIVIDED by the number of periods M) RAISED TO THE POWER of the number of periods M, MINUS 1

Example:EAR = (1+ 1.25%) RAISED TO THE POWER of 12, MINUS 1 (1+.0125) ^ 12 - 1 = 16.08%We are given the periodic (MONTHLY) interest rate, which is 1.25%.

The symbol ^ represents an exponent. In the above example, it could also bepresented as (1+.0125) 12 - 1 = 16.08%

Now that you know the difference between the APR (Annual Percentage Rate) and the EAR (Effective Annual Rate), you can ask questions to ensure that you know exactly how much interest you will be obligated to pay on borrowed money.

Simple Interest versus Compounded Interest

Note: You should know how to use eithera) a financial calculator

or b) a Scientific Calculator I prefer to use MS excel at my desk but a calculator is necessary if you are in class.

Refer to MS Excel file: A FIN Lesson 4 compounding daily vs. annual

House Price to Income Ratio

• House Price to Income Ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median familial disposable incomes, expressed as years of income.

Source: http://www.numbeo.com/propertyinvestment/indicators_explained.jsp

SOURCEhttp://www.numbeo.com/propertyinvestment/city_result.jsp?country=China&city=Changchun&displayCurrency=CNY

Saving for a DOWN PAYMENT

Price of apartment

4,280 CNY per square metre100 square metres428,000 CNY estimated purchase price 10,000 Down payment418,000 to pay over 25 years

Question: If I earn RMB 40,000 annually, is RMB 18,000 a good portion to spend paying towards my mortgage?

Influences on Personal Financial Planning

• Adult life cycle stage.• Marital status, household

size, and employment.• Major events.– Graduation, marriage, children, retirement, etc.

• Values.– What values are important to you?

• Global influences• Economic conditions

Life situation and personal values

Homework Question 3

• Suppose you just won a $100 million lottery and you are given the choice of taking a lump sum or payments over 20 years. Which would you do? Why?