Personal Finance and Investments A behavioural finance perspective by Keith Redhead

Personal Finance and Investments A behavioural finance perspective by Keith Redhead

Part 1
Basics of Money, Bond,
and Property Markets

Chapter 3
Interest rates and money
market investments
OBJECTIVE
The objective of this chapter is to provide readers with the knowledge required to be able to:
1. Distinguish between simple interest and compound interest.
2. Calculate average compound rates of interest.
3. Understand the nature of variable and fixed interest rates.
4. Be familiar with the convention for quoting interest rates on an annualised basis.
5. Distinguish between nominal and real interest rates.
6. Calculate interest rates and discount rates.
7. Distinguish between interest yield and total return.
8. Identify, and evaluate, money market investments.
9. Understand the implications of holding foreign currency deposits.
10. Compare the prospective returns from money market investments and stock market
investments.
Money market investments tend to be short term (maturities of a year or less) and low risk, in the
sense that their values are not strongly subject to market fluctuations.The most common form of
money market investment is the deposit, although there are other forms such as bills and
commercial paper.The return on deposits is in the form of interest.There are a number of features
of interest rates and interest payments of which investors should be aware.
SIMPLE INTEREST AND COMPOUND INTEREST
Suppose that £100 is invested for two years at an interest rate of 10% p.a.At the end of year 1, the
£100 will have grown to £110 [£100
1.1].
The £110 is invested at 10% for year 2 and grows to £121 [£100 X 1.1 X 1.1].The interest
of £21 includes £20 interest on the original investment of £100. This is known as simple
interest

Personal Finance and Investments A behavioural finance perspective by Keith Redhead