Time Value of Money

Interest Rate = Real Risk Free Interest Rate + Inflation Premium + Default Risk
Premium + Liquidity Premium + Maturity Premium

Continuous Compounding: FV = PVe
rn

Effective Interest Rate = (1+Periodic Interest Rate)
m
– 1; e
r
– 1 (for continuous
compounding)
DCF Applications

Discount Rates must be compatible with time periods.

Problems with IRR Rule
o
Size or Scale of Projects Differ
o
Timing of cash flows differ

Portfolio Return Measurement
o
Holding Period Return = (P
1
P
0
+D
1
)/P
0
o
Money Weighted Rate of Return (same as IRR).
This is sensitive to the
timing and amount of cash flows
.
o
Time Weighted Rate of Return (measures the compound rate of growth)
First measure the HPR (all r) and then…
R
TW
=[(1+r
1
)x…x(1+r
n
)]
1/N
– 1. 1/N might not be required, if you
are determining an annual yield after combining 4 quarter yields.

Money Market Yields
o
360
BD
D
r
Ft
=
; D=Dollar Discount (PF); F= Face Value; t=days remaining
o
Holding Period Yield = (P
1
P
0
+D
1
)/P
0
o
EAY (Effective Annual Yield) =
(1+HPY)
365/t
– 1
o
R
MM
=360r
BD
/(360tr
BD
); R
MM
= r
BD
F/P
0
; R
MM
= HPY 360/t
Statistical Concepts

Descriptive Statistics: Study of how data can be summarized effectively to
describe the important aspects of large data sets.

Statistical Inference: Making forecasts, estimates or judgments about a larger
group from a smaller group actually observed.

Measurement Scales
o
Nominal:
Weakest level of measurement; categorize but no ranking.
o
Ordinal:
Sort and order data.
o
Interval:
Ranking and assures that difference between scale values are
equal. Cannot form ratios.
o
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 Fall '08
 Compton
 Standard Deviation, Mean

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