Formulas

Present Value and Future Value of a Single Cash Flow FVt = PV0 (1 + r)t
PV0 = FVt (1 + r )t

Where: PV = present value FV = future value Present Value of Perpetuities

Perpetuity : PV0 =

CF1 r

Growing Perpetuity : PV0 =

CF1 rg

Present Value and Future Value of Ordinary Annuities

PV0 =

CF1 1 1 t r (1 + r )

FVt =

CF t (1 + r ) 1 r

Effective Annual Yield (or Effective Annual Interest Rate)

APR EAY = 1 + 1 m
Where: m = number of compounding periods per year. APR = Annual Percentage Rate (or Stated Annual Interest Rate). Risk and Return

Percentage return =

Cash flow over the period + Change in market value Beginning market value

Sample variance (for historical returns):

2 = (R1 R ) + (R2 R ) + ... + (RT R ) T 1

1
2 2

2 =
Where:

1 T Rt R T 1 t =1

T = total number of observations. Ri = return in period i. R-bar = average return over entire sample. 1

Variance of expected returns:

2 = P1 (R1 R ) + P2 (R2 R ) + ... + PT (RT R )

2 2

][
2

2 = Pt (Rt R )
T t =1

Where:

Pi = probability of being in state i. Ri = return in period i. R-bar = expected return.

Covariance and correlation:

Cov ( X , Y ) = P 1 X 1 X Y1 Y + P 2 X 2 X Y2 Y + ...
Cov ( X , Y ) = Pt X t X Yt Y
t =1 T

[(

)(

)] [(
)

)(

)]

)(

Where: Pi = probability of being in state i. Xi and Yi = return on security X and Y, respectively, in period i. X-bar and Y-bar = expected return on security X and Y, respectively.
Corr ( X , Y ) = X ,Y = COV ( X , Y ) X Y

Cov ( X , Y ) = X ,Y X Y
Portfolio Theory

E Rp =

[ ] w E[R ]
n i =1 i i

For two securities:

2 2 2 2 2 p = w1 1 + w2 2 + 2 w1w2 COV ( R1 , R2 )

2 2 2 2 2 p = w1 1 + w2 2 + 2 w1w2 12 1 2

Where: wi is the weight of security i in the portfolio.

Asset Pricing Theory Security Market Line (the CAPM):

E R = R + ER R i f m f

[ ]

[ ]

Where:

E[Rm] is the expected return of the market portfolio. Rf is the risk-free rate of return.
2 m

i =

COV ( Ri , Rm )

Where: m2 is the variance of the market portfolio.

Portfolio Betas:

p = wi i
i =1