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1

1.1

Accumulation function

a(t) a(t 1)

a(t 1)

A(t) A(t 1)

it =

A(t 1)

A(t) = k a(t)

it =

a(t) = 1 + it

i

it =

1 + i(t 1)

Under compound interest

a(t) = (1 + i)t

1

PV =

a(t)

1.2

a(t) a(t 1)

a(t)

d

i=

1d

i

d=

= iv

1+i

1d=v

dt =

i(m)

1+

m

1+i=

!m

d(m)

1

m

1d=

!m

1.3

Force of Interest

1 d

a(t)

a(t) dt

1 d

=

A(t)

A(t) dt

t =

Rt

a(t) = e

s ds

1.4

Power Series

x2 x3

+

+ ...

2

3

x2 x3

+

...

ln(1 + x) = x

2

3

ex = 1 + x +

1.5

PV =

R t2

a(t1 )

= e t1 t dt

a(t2 )

No formulas

Basic Annuities

S = (f irst term)

3.1

[1 (ratio)N ]

1 ratio

Annuities

1 vn

i

1 vn

a

n =

d

a

n = (1 + i)an = an1 + 1

an =

3.2

Accumulated values

(1 + i)n 1

i

(1 + i)n 1

sn =

d

sn = (1 + i)sn = sn+1 1

sn =

3.3

Deferred annuities/perpetuities

= v m an = am+n am

1

a =

i

1

a

n =

d

1 1

=1

d

i

m| an

3.4

Annuity tricks

a2n

= 1 + vn

an

a2n = an + v n an

= (1 + v n )an

a3n = an + v n an + v 2n an

= (1 + v n + v 2n )an

4

4.1

m-thly annuities

(m)

an

(m)

sn

1 vn

i

(m)

= (m) an = s1 an

(m)

i

i

(1 + i)n 1

=

i(m)

=

(m)

a =

(m)

(m)

a a

=

a

n =

4.2

i(m)

1

m

1 vn

an nv n

i

with P =first payment, Q=common difference

sn n

S = P sn + Q

i

A = P an + Q

Increasing annuities

a

n nv n

i

sn n

(Is)n =

i

sn1 (n + 1)

=

i

(Ia)n =

Decreasing annuities

n an

i

n(1 + i)n sn

(Ds)n =

i

(Ia)n + (Da)n = (n + 1)an

(Da)n =

Increasing perpetuities

1

1

1

= + 2

id

i

i

1

= 2

d

(Ia) =

(I

a)

P V (1, 2, 3, . . . , n, n, n, . . .) =

4.3

a

n

i

(m)

(Ia)n

(m)

a

n nv n

i(m)

1

1 2

2 3

= PV

,..., , ,..., , ,...

m

m m

m m

=

(m)

(m) a

n nv n

=

a

(m)

n

i

1 2 3

,

,

,...

= PV

m2 m2 m2

n nv n

a = a

I

n

4.4

1+k

1+i

n

ik

=va

n i0

with 1 + i0 =

1+i

1+k

Z n

PV =

f (t)v t dt

Z0 n

Rt

PV =

f (t)e 0 r dr dt

0

Palindromic annuity

n

P V (1, 2, 3, . . . , n 1, n, n 1, . . . , 3, 2, 1) = an a

P V (1, 2, 3, . . . , n 1, n, n, n 1, . . . , 3, 2, 1) = an+1 a

n

5

5.1

Yield Rates

Reinvestment rates

AV = 1 + i sn

i0

AV = n + i (Is)n

5.2

i0

2I

A+BI

with A = amount at beginning, B = amount at end and I = interest earned.

i=

5.3

- Dollar-weighted

i

A(1 + i) + B 1 +

=C

2

- Time-weighted

C

A+x

=1+i

A

A+x+B

5.4

- Portfolio method:

All members of the club, regardless of when they began to invest, get the

same yield rate.

- Investment year method (IYM):

Interest is credited in a way that recognizes when a member joined the club.

6.1

Amortizing a loan

Duration

t

Payment

R

Interest Paid

It = iBt1

Principal Repaid

Pt = R It

Oustanding Principal

Bt = Bt1 Tt

an

ian = 1 v n

vn

an v n = an1

2

..

.

1

..

.

ian1 = 1 v n1

..

.

v n1

..

.

an1 v n1 = an2

..

.

t

..

.

1

..

.

iant+1 = 1 v nt+1

..

.

v nt+1

..

.

..

.

ia1 = 1 v

a1 v = 0

Total

n an

an

With payments of

L

an

L

1 v nt+1

an

L nt+1

Pt =

v

an

L

Bt =

a

an nt

It =

6.2

Sinking funds

- Interest rate on loan = i

Interest rate on sinking fund = j

- Periodic interest payment on loan = It = i B0

- Periodic sinking fund deposit SF D =

- Total periodic payment R = i B0 +

B0

sn j

B0

sn j

7

7.1

Bonds

Price of a Bond

If C is the redemption value, F the face amount and r the coupon rate,

then:

P = F r an i + Cv n

If F r = Cg (usefull when n is unknown),

P = C + (F r Ci)an

and

P =

7.2

g

(C Cv n ) + Cv n

i

- If g > i: Premium = P C

call at earliest date

- If g < i: Discount = C P

call at latest date

7.3

- Price actually paid on date of purchase

Bt+k = Bt (1 + i)k

= (Bt+1 + F r)v 1k

- Quoted price (excl. accrued interest)

P = Bt+k kF r

= Bt (1 + i)k kF r

- Actual/Actual method for government bonds

30/360 method for corporate bonds

- Bond salemans method

Total interest = n Cg + C P

n Cg + C P

Average interest =

n

1

Average investment = (P + C)

2

Approximate yield rate per period i =

n Cg + C P

n

2 (P + C)

Financial Instruments

P V D, D(1 + k), D(1 + k)2 , . . . =

Price of a U.S. T-Bill

9

9.1

D

ik

n

P = 100 1

d

360

Inflation, spot and forward rate

1 + i0 =

1+i

1+r

If st is the spot rate up to year t and ft is the forward rate between year t

and t + 1,

(1 + st+1 )t+1 = (1 + st )t (1 + ft )

X CFt

P =

(1 + st )t

t

9.2

Duration

- Macaulay duration

P

t

t t v CFt

D= P

t

t v CFt

- Modified duration

D

P 0 (i)

=

P (i)

1+i

P (i + i) P (i) M odD P i

M odD =

- Portfolio duration

D=

9.3

P1 D1 + P2 D2 + P3 D3

P1 + P2 + P3

Convexity

P

C=

tt

(t + 1) v t+2 CFt

P t

t v CFt

P (i + i) P (i) M odD P i +

1

C P i2

2

9.4

Immunization

Redington immunization

- P V (assets) = P V (liabilities)

- PA0 = PL0

- PA00 = PL00

Full immunization

- P V (assets) = P V (liabilities)

- PA0 = PL0

- One asset CF before and one after liability CF

Interest-sensitive cash flows

P (i h) P (i + h)

2hP (i)

P (i + h) + P (i h) 2P (i)

Ef f ective convexity =

h2 P (i)

Ef f ective duration =

10

Introduction to Derivatives

No formulas

11

Forward Contracts

F orward = ST K

12

Options

- Call options

P ayof f (Call) = (ST K)+

P rof it(Call) = (ST K)+ F V [C(K, T )]

- Put options

P ayof f (P ut) = (K ST )+

P rof it(P ut) = (K ST )+ F V [P (K, T )]

- Put-Call Parity

C(K, T ) P (K, T ) = S0 eT KerT

10

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