Midterm 2 - Chapter 5-6 - Introduction to Finance PDF

Preview

Summary

Chapter 5-6...

Description

Future Values & Compound Interest - FV = Initial Investment * (1+r)^t - FV = PV * (1+r)^t Present Values - PV = Future value after T period / (1+r)^t Examples: Loan to the U.S. Gov & Saving for a future purchase - PV = Future payment * (1+r)^t - 1/ (1+r)^t → Discount factor Example 1: Finding the value of free credit PV = 8,000 + 12,000 + 1/(1.10)^2 PV = down payment + $ owed + discount price Example 2: Finding Interest rate PV = 1,000 * 1/(1+r)^10 = 777.40 1,000 = 777.40 * (1+r)^10 1,000 / 777.40 = (1+r)^10 Example 3: Double your money 2 = 1 * (1+r)^8 2 ^ (⅛) = 1 * (1+r) 2 ^ (⅛) = (1+r) 1.0905 = 1 + r .0905 = r Example 4: Multiple Cash flows

Annuity - Sequence of equally spent level of cash flows Example: Loan/home loan -

Present Value of t-year annuity = payment * annuity factor - Annuity Factor = [ 1/r - 1/r(1+r)^t ] Example 2: How to value Annuities PV = Mortgage payment * 360 month annuity factor 100,000 = Mortgage payment * 360 month annuity factor mortgage payment = 100,000 / 360 month annuity factor = 100,000 / annuity factor Mortgage payment = $1,028.61

Example 3: Future Value of an Annuity

Perpetuity - Continuous - Cash Payment for perpetuity = interest rate * present value - C = r * PV - PV = C/r Example 1: How to value perpetuities 100,000 = 1/r + 1/(1+r)^3

Effective manual rate = annuity compounded rate - ! + effective annual rate = (1 + monthly rate)^12 Consumer Price index (CPI) - % increase from one year to next measures the rate of inflation - Price * (1.05) ^50 1.05 → inflation rate ^50 → time Example: Real price CPI = 2.97...