I.

Interest Rate Measurement:

Accumulation Function, a(t): Accumulated value @ time (t) of an original investment of $1

Amount Function, A(t): Accumulated value @ time (t) of an original investment of $K

( )= ( )
=

Effective Rate of Interest,

Effective Rate of Discount,

(

1+

For simple interest, ( ) = 1 +

(
)
() (

()

() (

( )

For compound interest, ( ) = (1 + )

Nominal Rates:
o ( )=
(

o
o
o

( )
( )

( )

( )

o To convert between nominal rates, use the equivalence of rates:

(

(1 +

(1

1+

) = (1 +

( )

) = (1

( )

( )

Force of Interest:
o Measure of interest @ individual moments of time
o Interest payable continuously

( )
( )

( )

For Simple Interest:

( )

1+

For Compound interest:

= ln(1 + )

Real rate of interest:

o The real rate of interest takes into account the rate of inflation = r

II.

Valuation of Annuities:

Annuity Immediate:

(1 + ) =
(1 + ) =
=
+1
=
+1

Deferred Annuities: (n payments deferred for m periods)

Accumulated Value of (n) payments (m) periods after last payment:

o (1 + )

Perpetuity Immediate:

Relationship between immediate & due:

o Note that an annuity due is equivalent to an annuity immediate evaluated one period later

(1 + )

(
, = (1 + ) =

, =

Annuity Due:

Perpetuity Due:

Annuities Payable mthly:

o Each period has (m) payments of

( )

each

o This can be also attempted as an ordinary annuity with (

Arithmetically Increasing Annuities:

Using BAII Plus:

Set mode to BGN
N=n
PMT=1
FV=-n
CPT, PV
Divide by (i)

Increasing Perpetuity:

o
o

=(

Decreasing Annuities:

o
o

= (1 + )
=

o
o

= (1 + )

Using BAII Plus:

Set mode to END
N=n
PMT=-1
PV=-n
CPT, FV
Divide by (i)

) payments

Geometrically Varying Annuities:

)

o
o If

o If =

=
= (1 + )

Geometric Perpetuity Immediate:

o Present value is only defined for

Continuous Annuities:

o
o

<

=(

Continuous Varying Annuities:

o If the payment @ time (t) = ( ) and the force of interest is

( )

III.

Project Appraisals & Loans:

Net Present Value:

Measures the success of the investor

Internal balances do not matter

Measures the success if the broker

Lengths of internal intervals do not matter

Amortization: (Level payments)

o
o
o
o

IV.

IRR is the interest rate at which NPV = 0

Portfolio Rate of Return:

Time-weighted rate of return:

o
o

Dollar-weighted rate of return:

o
o

Internal Rate of Return:

o

)
= (1
=
= (1 + )
=

Bond Valuation:

Notation:
o

o
o

Yields:
o Nominal Yield: Annualized Coupon Rate

o Current Yield: Ratio of annualized coupon to price

o Yield-to-Maturity: Actual annualized yield rate.

Price of a bond:

(Frank)

Amortizing a Bond:
o
> ( > )

=
o

< ( < )

=(

,
=

o IMPORTANT NOTE ABOUT AMORTIZING A BOND: The book value at any point in time is equal
to a hypothetical redemption value had the bond been redeemed at that time. It also equals a
hypothetical price at which the bond is bought at that point in time.

Callable Bonds:
o For a fixed redemption value:

o For different calling prices:

V.

Cashflow Duration:

Price as a function of yield:

Modified Duration:

(1 + )

)(

( )

Relationship between Mod D & Mac D:

( )

( )

Macaulay Duration:

( )

= lim
=

Redington Immunization:
o
=
=
o
=
o
>
Full Immunization:
o
=
o
=
o

>

Stock Valuation:
o

=


o For geometrically increasing dividends:

&