Accurate Compounding Measurements
Below is the paper i wrote and my professor wrote the above comment that I posted which I will post below again. I need you to address it and answer the questions that were asked. I need at least a page include references.
Professor comment- In summation of your argument: Compounding can make things appear to be larger than they are. This effect can arise when returns resulting from an event are compounded over a long holding period. In this setting it is not uncommon for scholars and practitioners to describe returns resulting from compounding as a return caused by the individual event;this mistake results in exaggerating the significance of the event. Some of these errors are in favorite books, rare events such as news paper articles, investment advisors’ research reports, and finance journal article. Is accurate compounding measurements crucial for understanding the significance of high and low return days, corporate events such as stock splits, and mutual fund performance in your opinion if so why?Alternatively, why not?
Answer that I submitted to the professor
There are various forms of compounding. There is the compound where you will earn money on the interest that is in a savings account, the interest that is only calculated once on the principle, and the compound interest which is calculated among a given segment of time with an investment (Jin, H. S., 2003). Compounding interest has gone back for thousands of years and is a tradition for Israel to utilize. The principle remains separate from the interest in compounding.This is paid to the creditors at different intervals and thus, will never be added back to the principle amount. Interest pertains to an amount of funds that have been earned from an investment.
For instance, one can open a CD fund account up that yields a 10% interest rate. Therefore, if you had $500.00, invested these funds into a CD account, that CD account will periodically earn an interest rate of 10%. When such interest has been earned, it is then added to the balance of the account in which it was opened. This is known as the process of compounding (Timmermann, A., 2006).The concepts of what compounding refers to is that when in an interest rate is earned on a set amount of funds, it then gets added to the original balance.
For example, if the interest on a loan or savings account is only compounded once a year, then the following formula will be utilized, A=P(1+r)n. However, you were borrowing for a five-year period, your formula would like this, A=P(1+r)5. Such formulas can either apply towards the money you have invested, as well as the money you have borrowed if calculating the compounding interest on either or both. To break down the formula: (Jin, H. S., 2003).
-P= principle
-R= rate of interest
-N= number of years
-A= amount of funds accumulated after n years
Compound interest or rather the simple interest, is known as the rate paid on the investment. Once the interested has been added to the principle of the funds, this is when it will begin accruing interest (Timmermann, A., 2006). Once all calculations are computed, the new balance of this CD account would be $550.00. The Net Present Value is used by those working on projects to determine the future profits from them (Timmermann, A., 2006).For instance, when a company is working on a project, they can utilize the NPV to determine the possible earnings that the project will bring them.
The NPV can also calculate what the value of the dollar is today as opposed to what the value would be in the future of the dollar. There is a formula that companies and other financial professionals utilize. That formula is: (Timmermann, A., 2006).
The formula above is used to determine how much a project will yield in profits. When you use this formula to calculate, you will first compute by applying the discounted required rate of return. However, there is also a disadvantage to utilizing this formula. That disadvantage is because when calculating the rate of discount, it isn’t easy since such discounts aren’t known and there could be changes throughout the concepts of the project that are deemed to be unknown and that can arise (Timmermann, A., 2006). The results obtained from the NVP can be both be positive or negative. If it is deemed to be positive, then the return of the profits will be high. On the other hand, if it is negative, the return rates will not be all that good.
References
Guidolin, M., & Timmermann, A. (2006). Models for Stock and Bond Returns, Compounding. Journal of Applied Econometrics, 21(1), 1-22.
Jin, H. S. (2003). Compounding consumer interest: Effects of advertising campaign publicity on the ability to recall subsequent advertisements. Journal of Advertising, 32(4), 29-41.
Solution PreviewAccurate compounding measurements is crucial in the understanding of the significance of the low and high days of return and also in corporate events and mutual performance of funds. It is therefore crucial to understand the significance of these events to avoid the distortion………………………….