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
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
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
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
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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