A perpetuity is an investment that is intended to provide an expected return indefinitely, either remaining constant or growing by an incremental amount. Preferred stock is a common example with a preestablished dividend formula. An indefinite stream of payments cannot be compounded into a future value, but it can be discounted to a present value, providing an opportunity to determine the amount an investor should be willing to pay for a share of that stock.
An annuity is a stream of fixed periodic payments that is expected to be paid or received. Calculations of future value or present value are commonly performed on these payment streams for a wide number of reasons in business and personal financial analysis, as seen in the chapter focusing on single amounts, particularly in loan repayment. Annuities may be ordinary annuities, in which the first cash flow of a series occurs at the end of the first period, or annuities due, if the first cash flow occurs at the beginning point of the first period.
8.3 Loan Amortization
Loans are contracts between a lender and a borrower. Failure to observe the rules of that contract, such as payment of interest or repayment of the amount owed, can subject the borrower to substantial penalties as well as damage to their credit. Loan agreements bearing a fixed rate of interest have a scheduled amortization, or rate and time of repayments with interest. Several types of business and personal loans were described.
8.4 Stated versus Effective Rates
For a borrower to understand the true cost of financing, they must be familiar with interannual compounding, which can cause a stated interest rate that appears to be annual to actually be higher. The effective rate of interest was demonstrated to understand that true cost.
8.5 Equal Payments with a Financial Calculator and Excel
The use of two tools for managing and understanding the time value of money and its many applications was discussed: a professional financial calculator and the popular Microsoft Office Suite spreadsheet application Excel.