Exam 6: Measuring and Calculating Interest Rates and Financial Asset Prices

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a. Simple interest - A method of determining the interest rate on a loan in which interest is assessed only for the period of time the borrower actually has use of loanable funds.
b. Add-on interest - Interest on a loan is calculated on the full principal amount owed. The interest owed is then added to the principal and divided by the number of payments to determine the size of each installment payment that must be made.
c. Discount method - Borrower pays interest on a loan up front and receives total loan amount less interest due.
d. APR - Actual rate on a loan, reflecting all credit costs and adjusted for the declining amount owed on an installment loan, that must be quoted household borrowers under federal law.
e. Compounding of interest - A lender or depositor of funds earns interest income on both the principal amount of any funds owed and on accumulated interest as well.
f. APY - Annual percentage yield on a deposit, which adjusts for the average balance in the account and any fees charged the depositor and must be reported to the depositor before opening a new account.

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Using the discount interest formula: $350,000/($2,500,000-$350,000) = 16.28%. For the second part, multiply $2,500,000 times (1+ 0.1628) = $2,907,000. Here again, $407,000/($2,907,000-$407,000) = 16.28%.