Theory Part 1

Hello and welcome. In this section, you will learn a very important question type called the Big Six. A lot of the future questions will be built upon this question type, so it’s really important that you master it. Fortunately, it’s pretty straightforward. Let’s get started. The Big Six refers to the Six most important keys on your calculator. These keys are the following: I/YR, P/YR, N, PV, FV, PMT. All of them are located in the top row of your calculator. You will see that P/YR is in orange, which means you will need to first press the orange SHIFT key to access it. Let’s go over what each one of these keys represents. We will do a quick overview first and then dive into each key in more detail, so don’t worry if you don’t understand everything right away. …. Go through all keys You’ll need to memorize these six keys. While the order in which you use them doesn’t matter, I strongly recommend that you memorize and use them in the order presented here. This way every time you are solving a question, you can quickly jot down these six keys to get started and you won’t miss anything. You can download a cheat sheet with the Big Six in this section. You can use the cheat sheet at first but you can’t bring it with you to the exam, so try to memorize the Big Six as fast as you can. Now let’s dig deeper into each key and look at some examples The first two keys, I/YR and P/YR are responsible for the interest rate. For example, if interest rate is j2 = 5%, I/YR would be 5 and P/YR would be 2, because the rate has semi-annual compounding and there are 2 compounding periods per year (P/YR). If the rate given is j12 =6.7% (the compounding in this case is monthly), I/YR would be 6.7 and P/YR would be 12. Notice that even though the rate is 6.7%, we enter I/YR as simply 6.7 - the calculator automatically interprets this as 6.7%. To enter these values into the calculator, I’d type 6.7 and press I/YR, then type 12 and press SHIFT P/YR. The calculator is now storing in its memory the interest rate I/YR and the number of compounding periods per year (P/YR). Let’s now move on to the next key in our big six: N N is the amortization period expressed in compounding periods. So for example, if my mortgage is for 20 years, and my rate is j12 6.7%, P/YR is 12 and N would be 20 years x 12 compounding periods per year = 240. If the rate on a 3 year loan is given as j2 = 7%, P/YR is 2, N would be 3years x2 compounding periods per year and would equal 6. So just remember that N should ALWAYS be in compounding periods, not in years. Ok we are half way there. Let’s talk about the last 3 remaining keys in our big six: PV, FV, and PMT. As you may remember, PV stands for present value, FV is the future value, and PMT is the payment. These keys will take on different meaning depending on whether you think of them as the borrower or the investor. Let’s look at what Present Value, Future Value, and Payment mean from the perspectives of borrower or investor. From borrower’s perspective, the PV is the money you receive from the bank or the investor (+) FV is how much you owe, or will have to give away, at the end (negative). And as a borrower, you may be making payments on your loan (for example mortgage payments), so your PMT will be negative. From the investor’s prospective (you can think of a banker here giving someone a loan), they invest, or give away, money in the beginning (PV is negative). Then they will receive their money back at the end of the loan (FV is positive), and there may be payments (like mortgage payments) that they will receive, so the PMT is positive. Note that when you are solving the questions (and you’ll see that in the examples provided further in the course), you can pick either of these perspectives. So you can decide to think as a borrower, and make PV positive and the rest negative. Or you can think as an investor, and make the present value negative and the rest positive. As long as you stick with either one of these, you will be fine. It’s most intuitive for most people to think as a borrower, so for example if you have a question about a mortgage, as a borrower you will receive funds in the beginning (PV +), and then make payments and owe money at the end of the term (both FV and PMT will be negative). You will see how this works in practice later when we dive into some examples. Ok great, we have gone through the Big Six, or the Six most important keys on your financial calculator. You should now have an idea of what those keys mean. In the next video, we will look at how they are used in practice to solve real math problems that you will encounter on the exam.