Topic Two - Financial Mathematics

Topic Two - Financial Mathematics - Topic Two A Review of...

Info iconThis preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon
BUSINESS SCHOOL Topic Two: A Review of Financial Mathematics Craig Mellare
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
This Lecture By the end of this lecture you should be able to: - Calculate accumulated cash positions - Value assets with different cashflows - Understand different types of interest rates - Be able to adjust compound interest rates for different time periods - Understand annuities and their valuation - Understand how to use Present and Future Value Tables
Background image of page 2
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
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
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 2 3 4 5 6 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| $100
Background image of page 4
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)
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
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
Background image of page 6
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
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
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
Background image of page 8
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?
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Effective Simple Interest Rate definition - annual simple interest rate equivalent (ie. effective rate) to a given compound interest rate Over one year: (1+effective rate) = (1 + compound rate m ) m Other than one year: (1+effective rate) = (1 + compound rate m ) mn
Background image of page 10
Example A credit union offers you a 5 year loan at 5% pa compounded annually. What is the equivalent simple interest on the compound interest loan? effective rate = (1 + compound rate m ) mn -1 effective rate = (1+0.05) 5 - 1 = 28% over 5 years or 5.6% p.a.
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Now do you know which you would prefer? 5% pa compound interest for 5 years?
Background image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 48

Topic Two - Financial Mathematics - Topic Two A Review of...

This preview shows document pages 1 - 13. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online