[_daaisy]

I know this is a difficult subject, which is why I decided to take it during summer so I can put all my attention towards it. I understand pretty much everything we've covered up so far. But I'm having trouble with interest rates >__< I just get confused with converting it to the implied effective rate.
I know, you're suppose to either multiply or divide or use exponents to convert them, but how do you know which one to use. If anyone can help, that would be great.

[feiyingx]

Do you have some sample questions? It'll be easier to explain that way.

[vividified]

you mean given a monthy rate then getting into an annual rate? etc
the thing about finance is you do tons of questions it is annoying but i found it was the best way to help
but give us some examples and see how we can help you.

[_daaisy]

well here's one example we did in class

Coca Cola stock's last divided was $0.75. Dividend are paid each quarter, the next divided is in 1 month and each divided is expected to grow by 1% each quarter. The relevent discount rate given Coke's risk is 12%. What is the current price of Coke's stock.

ok, so i know i have to find the PV of the growing perpetuity first before i can find the PV today, i understand that part. but i don't get how to convert the rate.

my professor showed this to get the right r:
r= [ (1+0.12)^3/12 ] - 1 = 0.02873 = 2.873%

so if anyone can show me how and why he used this step instead of multiplying or dividing to get the r, that would be great. and hopefully i can get a better understanding.

[feiyingx]

In this problem, the original interest rate is given as 12% per year. In general, one form of the interest rate eqn is as follows:

r = [(1+rate in terms of years)^time period in terms of years] - 1.

Since your interest rate is in terms of years, then your time period must be in terms of years as well. And since we want to find the interest rate per quarter [which is 3 months], then the time period is 3/12 of a year. Therefore r = [(1+0.12)^3/12]-1

And regarding your 'multiplying and dividing', can you elaborate a bit more on what you mean?

well here's one example we did in class

Coca Cola stock's last divided was $0.75. Dividend are paid each quarter, the next divided is in 1 month and each divided is expected to grow by 1% each quarter. The relevent discount rate given Coke's risk is 12%. What is the current price of Coke's stock.

ok, so i know i have to find the PV of the growing perpetuity first before i can find the PV today, i understand that part. but i don't get how to convert the rate.

my professor showed this to get the right r:
r= [ (1+0.12)^3/12 ] - 1 = 0.02873 = 2.873%

so if anyone can show me how and why he used this step instead of multiplying or dividing to get the r, that would be great. and hopefully i can get a better understanding.

[_daaisy]

And regarding your 'multiplying and dividing', can you elaborate a bit more on what you mean?

here some examples with regards to that:

1.
given an effective annual intrest rate to 10%, determine the equivalent rate per . . .
a) month compounded monthly --> here you would use the exponents to get an equal rate of 0.7974%
b ) year compounded monthly --> here you multiply what you got at a) 0.7974% X 12 to get = 9.569%

2.
given a rate of 6% per month compounded quarterly, find the effective yearly rate
6 X 3 = 18%
r = [ (1+0.18)^(12/3) -1 ] = 93.8777%


^^ how do you know when to use exponents first.
also, another question i have for when using the exponents equation, when do you know to divide by 12 like the first example and when 12 is divided into another number, like 3 in the second example.

3.
2% per month compounded yearly --> 2 X 12 = 24%

4.
25% per decade compounded biyearly --> 25/5 = 5%

^^ how do you know when to multiply or divide.



another example:
your father has decided he will help you with a quarterly payment of $1000. he will pay you 10 times starting one month from today. if the interest rate is 12% per year compounded semi-annually what is the PV of these series of cash flows.

^^ this is a h/w question so i'm not sure if i'm doing this right. here's what i did though:

r = 12/2 = 6% --> r = [(1+0.06)^(3/12)]- 1 = 1.4673%


thanks for taking your time to help me