And we use those tools to discount cash flows, that is move them back in time and

compound cash flows are moving forward in time.

We introduced some useful shortcuts.

Namely, the present value of an annuity formula and the present perpetuity formula

as well as formulas for the present value of grown annuity and a growing perpetuity.

Then we closed off the topic with a discussion of taxes and inflation and

investigated how those two concepts would impact both our dollar return and

the purchasing power of those dollars.

Now, I want to turn to interest rates in this lecture and this isn't so

much a new topic as much as it is really an extension of the time value of money to

incorporate institutional details and make things a little bit more realistic.

So we're going to talk about interest rate quotes and

we're going to learn how to deal with cash flows that don't arrive once a year, but

may arrive monthly or semi annually.

And we're also going to discuss how to deal with compounding of interest when

it's not just annually.

So let's get started.

Here is a snapshot from December of 2014 of rates on five year jumbo CDs,

where CD just stands for certificate of deposit.

It is a savings vehicle most banks offer and here is one, two, three, four banks.

Now the jumbo that just refers to, I think a minimum deposit of $100,000.

So these are big deposits.

And one of the things you notice when looking at these rates is when you're

looking at these savings vehicles is that each one has two different rates.

It has a rate and an APY and these numbers 2.37, 2.4, they're different.

So that begs the question is why are they different?

How are they related?

And most importantly, which one is going to tell me how much money I'm going

to make when I invest in this product?

Well, let's go through this starting with the rate.

The rate refers to the APR of the Annual Percentage Rate.

That measures the amount of simple interest earned in a year.

Simple interest is just the interest earned without compounding,

ignoring compounding.

And if you're wondering what compounding is we're going to talk about it, but

just as a preview.

Notice underneath rate, we have compounded daily.

Simple interest ignores that compounding frequency.