interest_rates_and_present_value

interest_rates_and_present_value - ( 29 ( 29 ( 29 n B r R r...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
INTEREST RATES AND PRESENT VALUE Even if there were no inflation, a dollar today is not worth a dollar one year from now ( or anytime in the future for that matter ). The reason for this: interest rates , which tell us how much more money is worth today than in the future. The future value ( FV ) of a sum of money $ P , n years from now, given an interest rate of r is ( 29 n r P FV + = 1 $ . The present value ( PV ) of a sum of money $ A , received n years from now, given an interest rate of r is ( 29 n r A PV + = 1 $ . Most assets ( real and financial ) provide a stream of revenues in the future. In some cases ( as for bonds ), the streams of revenues are known with certainty; in other cases ( as for stocks ), the streams of dividends are uncertain. The prices of all such assets are equal to the sum of present value of each future payment. For example, if a bond pays $ R each year for n years, given an interest rate of r , the price of the bond, B P , is its present value:
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ( 29 ( 29 ( 29 n B r R r R r R PV P + + + + + + = = 1 $ 1 $ 1 $ 2 . Note that, other things equal, interest rates and bond prices are inversely related . Consider a perpetuity which pays $ R each year forever. Given an interest rate of r , the price of the perpetuity, B P , is its present value: r R P B $ = . The inverse relationship between interest rates and bond prices is even more evident in the above expression. Most investment projects involve streams of costs and benefits occurring at different times. The net present value ( NPV ) of a project is equal to the difference between the present value of the stream of benefits and the present value of the stream of costs, i.e., NPV = PV of Benefits PV of Costs. If the NPV is positive, then one should undertake the project; if the NPV is negative, then one should not undertake the project....
View Full Document

Ask a homework question - tutors are online