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Lecture 2:The Time Value of Money
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View Full Document This lecture note covers:
:: Simple Interest vs. Compound Interest ::
:: Fundamental tools for financial analysis ::
§
Present Value and Future Value/ Discounting
§
Compounding Intervals
§
Continuous Compounding
:: Useful Shortcuts ::
§
Annuities and Perpetuities
§
Growing annuities and perpetuities
C
n
: Future value at end of n periods of C
0
dollars today
C
1
= C
0
+ rC
0
(deposit C
0
for 1 period)
C
1
= C
0
(1 + r)
C
2
= C
1
+ rC
1
(deposit C
1
for 1 period)
C
2
= C
1
(1 + r) = C
0
(1 + r)
2
Recursively
C
n
= C
0
(1 + r)
n
Compound Interest Formula
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View Full Document Example: $1000 at 5% for 5 years
Year
Beginning
Amount
Interest
on
Original
Principle
Interest
on
Interest
Ending
Amount
1
1000.00
50.00
0.00
1050.00
2
1050.00
50.00
2.50
1102.50
3
1102.50
50.00
5.13
1157.63
4
1157.63
50.00
7.88
1215.51
5
1215.51
50.00
10.78
1276.28
C
5
= 1000(1.05)
5
= 1000
×
1.2763
Simple vs. Compound Interest
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View Full Document Present Values/Discounting
C
n
= C
0
(1 + r)
n
FV
n
= PV
0
(1 + r)
n
PV
0
= FV
n
/(1 + r)
n
Present values are ADDITIVE
PV(C
1
,C
2
,...,C
n
) = PV
1
(C
1
) + PV
2
(C
2
) + .
.. +
PV
n
(C
n
)
=
t
=
1
n
∑
PV
t
(C
t
)
Example :
"Claim X" : $100 a year at the end of each year for 10
years.
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This note was uploaded on 02/28/2011 for the course FIN 300 taught by Professor Olander during the Spring '08 term at ASU.
 Spring '08
 Olander
 Time Value Of Money, Compounding, Future Value, Interest

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