69A810E2 - Topic 2 Review of Financial Mathematics Craig...

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Topic 2 Review of Financial Mathematics Craig Mellare Corporate Finance 1 University of Sydney
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This Lecture By the end of this lecture you should be able to: calculate accumulated cash positions value assets with different cashflows understand annuities and their valuation be able to generate Present Value Tables
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Aim of Financial Mathematics Reduce a series of cashflows (asset) to a common $ base taking into account the time value of money for deciding: which assets are more value able appropriate price to pay for assets
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Time Value of Money Which one of these assets would you rather own? Asset 1 Year 0 1 2 3 4 5 6 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| $100 Asset 2 Year 0 1 3 4 5 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| $100
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Simple Interest definition under simple interest, the amount of interest paid per period does not vary and is based on initial cash flow (principal or PV) FV = PV + $Interest but $Interest = PV x r hence FV = PV + (PV x r) FV = PV (1+r) FV = PV (1+r)
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Example A credit union pays 5% p.a. simple interest; you deposit $1,000; what will be in the account in 4 years? FV = PV (1+r) FV = PV (1+r) FV = 1,000 x (1 + 0.20) = $1,200 FV = 1,000 x (1 + 0.20) = $1,200
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Compound Interest definition compound interest arrangements allow for interest to be received during each set period (compounding period), and interest to be earned on the principal plus the interest key: interest earned on interest FV = PV (1+r) n r = interest rate per period n = number of periods
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Example A credit union pays 5% p.a. compounded yearly, you deposit $1,000, what will be in the account in 4 years? FV = PV (1+r) n FV = 1,000 (1+0.05) 4 = 1,216
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What happens if we are borrowing money? Option A - 5% pa compound interest for 5 years? Option B - 5.6% pa simple interest for 5 years? Q: What is the effective simple interest on Option A?
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Effective Simple Interest Rate definition annual simple interest rate equivalent (ie.
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This note was uploaded on 08/13/2011 for the course FINC 3011 taught by Professor N/a during the Three '10 term at University of Sydney.

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69A810E2 - Topic 2 Review of Financial Mathematics Craig...

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