Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

10. Time Value of Money

Time Value of Money Equations

Financial Accounting

10. Time Value of Money

Time Value of Money Equations

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Multiple Choice

Which of the following best describes the formula \( EAR = (1 + \frac{rate}{m})^m - 1 \)?

It calculates the effective annual rate (EAR) given a nominal rate compounded m times per year.

It determines the future value of an ordinary annuity.

It computes the simple interest earned over one year.

It calculates the present value of a future sum using continuous compounding.

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Verified step by step guidance

Understand the formula: The formula \( EAR = (1 + \frac{rate}{m})^m - 1 \) is used to calculate the Effective Annual Rate (EAR), which accounts for the effects of compounding within a year.

Break down the components: \( rate \) represents the nominal interest rate, and \( m \) is the number of compounding periods per year. The formula adjusts the nominal rate to reflect the impact of compounding.

Interpret the formula: The term \( \frac{rate}{m} \) divides the nominal rate by the number of compounding periods, giving the periodic rate. Raising \( (1 + \frac{rate}{m}) \) to the power of \( m \) accounts for compounding over all periods in the year.

Subtract 1: The subtraction of 1 at the end of the formula removes the principal amount, leaving only the effective annual rate (EAR), which represents the true annual return on investment after compounding.

Clarify the purpose: This formula specifically calculates the EAR, which is the annualized interest rate that includes the effects of compounding, making it distinct from simple interest or other financial calculations like future value or present value.