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Chapter 4
Assignment 1
Compounding – the one period case
Discounting – the one period case
Compounding beyond one year
Discounting beyond one year
Compounding more rapidly than once a year
Annual percentage rate vs. effective annual yield
Continuous compounding
Multiperiod valuation
Short cuts for multiperiod valuation:
Perpetuity
Growing perpetuity
Annuity
Growing annuity
Examples
Pension fund and Mortgage
4.1 – The One Period Case
Compound Value
= Future Value
Present Value
= Future Value/(1+Interest Rate) = C
1
/1+r
R = rate of return/discount rate
Net Present Value
(NPV) = PV in future – Cost today
Cost = current PV of item
4.2 – The Multiperiod Case
Compounding
= earning interest on money over several interest earning periods
Simple interest = nr
Interest on interest = r
n
N is some coefficient, but usually it’s T, time
Compound interest
= each interest payment is reinvested
FV = C
0
+(1+r)
T
Discounting
= the process of deriving the PV of a future cash flow
Present Value factor
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 Spring '10
 jaffe
 Annual Percentage Rate, Compounding

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