739 views

Uploaded by Wo Kit Lam

- Chapter 02
- Bahasa Inggris Bisnis Economic Vocabulary
- Final Examination Gen Math Sy 2018-2019
- DK5739_CH6
- 3. Chapter 3 part 1
- SPreCalc7_04_01 (1)
- Equations on Ti 86
- Solution TVM
- Chapter 2 part 1.ppt
- UNIT II
- showaibs financial mathematics assignment
- Ch. 2 Problems Joined
- ECON430 Solution
- Lecture 8 9
- Economics(shifted series)
- IMTG_ACES.pptx
- Part 3. Usury Law
- Demonetization through segmented markets
- RealWorldGraduation Question 34 Sound Investments
- Retire Rich Retire Young

You are on page 1of 65

Money-time relationships

Money has a time value because it can earn interest (or profit)

over time.

Simple interest:

Total interest is linearly proportional to the amount of loan

(principal), the interest rate, and the number of interest periods.

I = (P)(N)(i)

I : total interest

P : principal

N : number of interest periods

i : interest rate per interest period.

interest rate of 10%. How much will you repay at the end of 3rd

year?

I = (10, 000)(3)(0.1) = $3, 000. You need to pay $13,000.

SEEM2440A/B Chapter 4 - Time value of money

Compound interest:

Suppose the interest accumulates as follows:

Period, p Amount owed Interest amount Amount owed

at the start of p for p at the end of p

1 $10,000 $1,000 $11,000

2 $11,000 $1,100 $12,100

3 $12,100 $1,210 $13,310

$13,310-$10,000=$3,310>$3,000 (interest in simple interest

calculation).

Interest accumulates over the earned interests in the previous

periods. More common than simple interest.

periods is P(1 + i)N = $10, 000(1.1)3 .

Economic equivalence

the interest rate

the amounts of money involved

the timing of the monetary receipts or expenses

the manner in which the interest (or profit) is paid

Back to the example with compound interest:

$10,000 now is equivalent to $11,000 one year from now, and it

is equivalent to $12,100 two years from now under the fixed

compound interest rate of 10%. One should be indifferent

between the following three alternatives:

1 Pay/receive $10,000 now

2 Pay/receive $11,000 one year from now

3 Pay/receive $12,100 two years from now

Example 4.2 (3 plans for repayment of $10,000 in three years

at 10% per year)

You owe $10,000 to your credit card company. You have 3

plans to pay the balance back:

end of third year.

Year Amount owed Interest Principal payment Total pmnt.

1 10,000 1,000 0 1,000

2 10,000 1,000 0 1,000

3 10,000 1,000 10,000 11,000

Total: 3,000 13,000

Plan 2: Pay principal and interest in one payment at the end of

third year.

Year Amount owed Interest Principal payment Total pmnt.

1 10,000 1,000 0 0

2 11,000 1,100 0 0

3 12,100 1,210 10,000 13,310

Total: 3,310 13,310

Year Amount owed Interest Principal payment Total pmnt.

1 10,000 1,000 3,021 4,021

2 6,979 697.9 3,323 4,021

3 3,656 365.6 3,656 4,021

Total: 2,063.5 12,063

Plan 1,2 and 3 are all equivalent at the compound interest rate

of 10%! (Why? You can answer it at the end of this chapter.)

Cash-flow diagrams

i = effective interest rate per interest period

N = number of compounding periods

P = the present sum of money

F = future sum of money

A = end-of-period cash flows in a uniform series for a specified

number of periods, starting at the end of first period and

continuing through the last period.

In a cash-flow diagram:

horizontal line represents time scale,

arrows represent cash flows. Downward arrows represent

expenses (negative cash flows or cash outflows) and

upward arrows represent receipts (positive cash flows or

cash inflows).

The cash-flow diagram is dependent on the point of view.

In the course, without explicitly mention, the company’s

(investor’s) point of view will be taken.

SEEM2440A/B Chapter 4 - Time value of money

General setting

Beginning of

period 1

End of period 1 F

0

1 2 3 N-1 N

i % per period

Example 4.3

Show the cash flow diagrams for Plans 2 and 3 from the credit

card company’s viewpoint. Identify i, P, F, A.

Solution

Plan 2 Plan 3

F = $13,310 A= $4,021

0 0

2 3=N 1 2 3=N

1

End of Year (EOY) End of Year (EOY)

P = $10,000 P = $10,000

Example 4.4

requires a capital investment of $50,000 now, and it will

generate uniform annual revenue of $6,000. Further, the

project will have a salvage value of $4,500 at the end of the fifth

year and it will require $3,000 each year for the operations.

Develop the cash-flow diagram for this project from the

investor’s viewpoint.

Solution

$4,500

0 1 2 3 4 5

End of Year (EOY)

$50,000

Rules for performing calculations with cash flows

flows:

1 Cash flows cannot be added or subtracted unless they

occur at the same point in time.

2 To move a cash flow forward in time by one time unit,

multiply the magnitude of the cash flow by (1 + i).

3 To move a cash flow backward in time by one time unit,

divide the magnitude of the cash flow by (1 + i).

Interest formulas relating P and F

0

1 2 … N−1 N

End of Period

Interest formulas relating P and F

F = P(1 + i)N .

parentheses is read "find F given P at i% interest per

period for N interest periods".

Interest formulas relating P and F

0

1 2 … N−1 N

End of Period

Interest formulas relating P and F

N

P = F 1+i 1

= F(1 + i)−N .

parentheses is read "find P given F at i% interest per

period for N interest periods.

Example 4.5: You deposit $50,000 now in a savings account at

an interest rate of 8% per year. How much will you have in this

account at the end of fifth year? Assume the interest rate is

constant at 8% for the next five years.

Solution: P = 50, 000, i = 8% per year, N = 5

F = P(F/P, 8%, 5) = 50, 000(1 + 0.08)5 = $73, 466

account now so that you will have $100,000 in this account 6

years from now? Assume that the interest rate is 5% per year.

Solution: F = 100, 000, i = 5% per year, N = 6

P = F(P/F, 5%, 6) = 100, 000(1 + 0.05)−6 = $74, 627

General setting with annuities (A)

A A A A A

0 N

1 2 3 N-1

i % per period

P F

Interest formulas relating P,F, and A

N periods at an interest rate of i% per period, where the first

receipt occurs at the end of the first period and the last one

occurs at the end of the Nth period.

Finding F when A is given

Find the future equivalent at the end of Nth period of each cash

flow A. Then sum them up.

Future equivalent at the end of period N of the cash flow that

happens at the end of period 1: A(F/P, i%, N − 1)

Future equivalent at the end of period N of the cash flow that

happens at the end of period 2: A(F/P, i%, N − 2)

...........

Future equivalent at the end of period N of the cash flow that

happens at the end of period N: A(F/P, i%, 0)

F = A(F/P, i%, N − 1) + A(F/P, i%, N − 2) + ... + A(F/P, i%, 1) +

A(F/P, i%, 0)

⇒ F = A[(1 + i)N−1 + (1 + i)N−2 + ... + (1 + i)1 + (1 + i)0 ].

Note that

[(1 + i)N−1 + (1 + i)N−2 + (1 + i)N−3 + ... + (1 + i)1 + (1 + i)0 ] =

N−1 h in

1

(1 + i)N−1 (1+i)

P

n=0

ar0 + ar1 + ar3 + ... + arN−2 + arN−1 , where a = (1 + i)N−1 ,

r = (1 + i)−1 .

Note that the sum of the first N terms in a geometric series is:

N−1

P n a(1−rN )

ar = 1−r .

n=0

Therefore we have the following:

N−1 h in (1+i)N−1 − 1

1 (1+i)N −1

(1 + i)N−1 (1+i) (1+i)

P

= 1− 1

= i

n=0 (1+i)

We find:

h i

(1+i)N −1

F=A i

Finding A when F is given

h N

i

From F = A (1+i)i −1 ,

h i

i

A=F (1+i)N −1

Example 4.7: You plan to deposit $2,000 to your savings

account at the end of every month for the next 15 months

starting from the next month. If the interest rate you can earn is

2% per month how much money will accumulate immediately

after your last deposit at the end of the 15th month?

Solution: h per15month,

h A N= 2,i000, i = 2% i N = 15 months. F =?

(1+i) −1 (1.02) −1

F=A i = 2, 000 0.02 = $34, 587

in your savings account at the end of each month for the

following 10 months in order to accumulate $75,000 at the time

of the 10th deposit? Assume that the interest rate you can earn

is 4% per month and the first deposit will be made next month.

Solution:

h F = 75, h per month,

i 000, i = 4% i N = 10 months. A =?

i 0.04

A = F (1+i)N −1 = 75, 000 (1.04)10 −1 = $6, 247

Finding P when A is given

Given P = F(P/F, i%, N) and F = A(F/A, i%, N), we can derive

P = A(P/A, i%, N) as follows:

N

A (1+i)i −1 (1 + i)−N

h i

(1+i)N −1

P=A i(1+i)N

Finding A when P is given

h N −1

i

From P = A (1+i)

i(1+i) N ,

h i

i(1+i)N

A=P (1+i)N −1

SEEM2440A/B Chapter 4 - Time value of money

Example 4.9: How much should you deposit to your savings

account now at an annual interest rate of 10% to provide for 5

end-of-year withdrawals of $15,000 each?

Solution:

h A N= 15, h per

i 000, i = 10% iyear, N = 5 years. P =?

(1+i) −1 (1.1)5 −1

P = A i(1+i)N = 15, 000 0.1(1.1)5 = $56, 862

you will repay with equal annual payments for the next 5 years.

Suppose the interest rate you are charged is 8% per year and

you will make the first payment one year after receiving the

loan. How much is your annual payment?

Solution:

h P =N 100, h per year,

i 000, i = 8% i N = 5 years. A =?

i(1+i) 0.08(1.08)5

A = P (1+i)N −1 = 100, 000 (1.08)5 −1 = $25, 046

SEEM2440A/B Chapter 4 - Time value of money

Deferred annuities

Table 1: Ordinary annuities

Year 0 1 2 3 ... N

Cash flow - A A A ... A

Year 0 1 2 3 ... J J+1 J+2 ... N

Cash flow - - - - ... - A A ... A

Table 2 as of time 0 (P0 )?

Table 2 as of time N (FN )?

FN = A(F/A, i%, N − J)

Example 4.11

P0=?

5,000

2,000 …….. 2,000

6 7 8 9 10

0 1 2 3 4 5 11 12 13 14 15

i=10 % per

period

Solution

5000(P/F, 10%, 11) + 2000(P/A, 10%, 4)(P/F, 10%, 11)

= $14, 729.

Arithmetic gradient series

amount (G) from one period to the next. See the cash flow

diagram in the next slide.

Cash flows in arithmetic gradient series

(N-1)G

(N-2)G

3G

2G

G

0 1 2 3 4 N-1 N

i% per period

Interest formulas

F = G(F/P, i%, N − 2) + 2G(F/P, i%, N − 3) + 3G(F/P, i%, N −

4) + ... + (N − 1)G(F/P, i%, 0) ⇒

F = G[(1 + i)N−2 + 2(1 + i)N−3 + 3(1 + i)N−4 + ... + (N − 1)(1 + i)0 ]

(1)

Multiply both sides of the expression in (1) with (1 + i):

F(1+i) = G[(1+i)N−1 +2(1+i)N−2 +3(1+i)N−3 +...+(N−1)(1+i)1 ]

(2)

Subtract (1) from (2):

Fi = G[(1 + i)N−1 + (1 + i)N−2 + (1 + i)N−3 + ... + (1 + i)1 − (N − 1)]

F = Gi [(1 + i)N−1 + (1 + i)N−2 + (1 + i)N−3 + ... + (1 + i)1 + 1] − GN

i

h i

G (1+i)N −1 GN G GN

F= i i − i ⇒F= i (F/A, i%, N) − i .

Finding P when G is given

We know the formula to find F given G, and the formula to find

P given F. We can use these formulas to find (P/G, i%, N) as

follows:

h N

i

P = Gi (1+i)i −1 − GN

i (P/F, i%, N)

Recall (P/F, i%, N) = (1 + i)−N

Hence,

h i

1 (1+i)N −1 N

P=G i i(1+i)N

− (1+i)N

.

Finding A when G is given

We know the formula to find F given G, and the formula to find

A given F. We can use these formulas to find (A/G, i%, N) as

follows:

A = Gi (F/A, i%, N) − GN

i (A/F, i%, N)

⇒ A = Gi − GNi (A/F, i%, N)

(A/F, i%, N) = (1+i)i N −1

Hence,

h i

1 N

A=G i − (1+i)N −1

.

Example 4.12

18,000

16,000

14,000

12,000

10,000

0 1 2 3 4 5

a) P=? b) A=?

0 1 2 3 4 5 0 1 2 3 4 5

Solution

$18,000

$16,000

$14,000

$12,000

$10,000

0 1 2 3 4 5

$8,000

$6,000

$10,000

$4,000

+ $2,000

0 1 2 3 4 5 0 1 2 3 4 5

Solution

= $51, 631.

A = P(A/P, 10%, 5)

= 51631.47(A/P, 10%, 5)

= $13, 620.

Geometric gradient series

percentage (f ) from one period to the next. See the cash flow

diagram in the next slide.

A −A

Note that Ak = (1 + f )Ak−1 and f = kAk−1k−1 , where f is the

constant rate of change.

Cash flows in geometric gradient series

i% per period

0 1 2 3 4 N-1 N

A1

A2=(1+f)A1

A3=(1+f)2A1

A4=(1+f)3A1

AN-1=(1+f)N-2A1

AN=(1+f)N-1A1

Interest formulas

geometric series.

Use the previously derived formulas (A/P,i%,N) and (F/P,i%,N)

to find A and F, respectively.

Note that (P/F, i%, N) = (1 + i)−N and Ak = (1 + f )k−1 A1 ,

2 ≤ k ≤ N.

Hence,

P = A1 (1 + i)−1 +(1 + f )(1 + i)−2 + ... + (1 + f )N−1 (1 + i)−N

2 N−1

⇒ P = A1 (1 + i)−1 1 + 1+f 1+i + 1+f

1+i + ... + 1+f

1+i

N−1

(1−xN )

xn =

P

Using the summation formula 1−x , when x 6= 1, we

n=0

can derive the following

expression:

1+f

(Note that x = 1+i , and x 6= 1 reduces to i 6= f )

(

A1 [1−(P/F,i%,N)(F/P,f %,N)]

i−f 6 i

f =

P=

A1 N(P/F, i%, 1) f =i

(F/P, f %, N) = (1 − 0.1)N .

Example 4.13

plant in the Midwest have determined that a small amount of a

newly available chemical additive will increase the water

repellency of Coleman’s tent fabric by 20%. The plant

superintendent has arranged to purchase the additive through

a 5-year contract at $7,000 per year, starting 1 year from now.

He expects the annual price to increase by 12% per year

thereafter for the next 8 years. Additionally, an initial investment

of $35,000 was made now to prepare a site suitable for the

contractor to deliver the additive. Use i=15% per year to

determine the equivalent total present worth of all these cash

flows.

Solution

0 1 2 … 5 6 … 13

…

…

$7,000(1.12)

$7,000

$35,000

$7,000(1.12)8

Solution

7,000[1−(P/F,15%,9)(F/P,12%,9)]

0.15−0.12 (P/F, 15%, 4) = $83, 232.

Example 4.14

10,000

9,500

9,000

8,500

8,000

7,500

7,000

0 1 2 3 4 5 6 7 8 9

2,000

2,500

X X X X

0 1 2 3 4 5 6 7 8 9

X=?

Solution

X(P/A, 10%, 7) − 2X

3 (P/A, 10%, 3) + 2, 500(P/F, 10%, 9).

X(4.8684) − 2X3 (2.4869) + 2, 500(0.4241)

⇒ X = 9, 935.8

Example 4.15

annual deposits into a savings account, with the first deposit

being made on the child’s 5th birthday and the last deposit

being made on the 15th birthday. Then, starting on the child’s

18th birthday, four end-of-year withdrawals will be made at the

amounts of $2,000, $2,400, $2,800, and $3,200, respectively. If

the effective annual interest rate is 8% during this period of

time, what are the annual deposits in years 5 through 15?

Solution

= [2, 000(3.3121)+400 (4.650)] (0.8573) (0.0601) = $437.14

Nominal and effective interest rates

You are given two 1-year fixed deposit saving plans. The

interest rate of the two plans are:

Plan 1: 12% per year (compounded annually).

Plan 2: 12% per year compounded monthly.

In Plan 1, the interest rate "12% per year" is known as the

effective interest rate per year, the same as the one we use

before.

is known as the nominal interest rate per year with the

compounding period 1 month (or compounding frequency 12).

In general, the nominal and effective interest rates are related

by

!M

r(M)

i= 1+ −1 (NOM-EFF)

M

where

i: effective interest rate per period;

r(M) : nominal interest rate per period with compounding

frequency M.

Example 4.16

You own a credit card which has a nominal interest rate of 15%

per year, compounded monthly. a) What is the effective annual

interest rate? b) Suppose your balance as of today (year 0) is

$10,000. How much will you owe to the credit card company at

the end of 3 years if you do not make any payments during 3

years?

Solution: 12

a) i = 1 + 0.15

12 − 1 = 16.07%

b) Use formula (F/P,i%,N). We can use effective annual interest

rate of i% and N=3.

P(F/P, i%, N) = 10, 000(F/P, 16.07%, 3) = 15, 637

Alternatively, we can use interest rate per month 0.15

12 = 0.0125

and N=3(12)=36.

P(F/P, i%, N) = 10, 000(F/P, 1.25%, 36) = 15, 639

Continuous compounding

effective (continuous) interest rate?

r M

We know that i = 1 + M − 1.

r M

lim i = lim 1 + M − lim 1

M→∞ M→∞ p M→∞

Recall: lim 1 + p1 = e (natural logarithm base)

p→∞

M

Let r =p

h pr i h p ir

⇒ i = lim 1 + 1p − 1 = lim 1 + 1p −1

p→∞ p→∞

⇒ i = er − 1

We can obtain the interest formulas relating P,F,A, by using the

relation i = er − 1.

SEEM2440A/B Chapter 4 - Time value of money

Payment Period and Compounding Period

flow:

Type 1: PP = CP (Done!)

Type 2: PP > CP

Type 3: PP < CP

Type 2: PP > CP

The strategy in this case is to find the effective interest rate per

PP by using the relation (NOM-EFF).

Example 4.17: For the past 7 years, a quality manager has paid

$500 every 6 months for the software maintenance contract of

a LAN. What is the equivalent amount after the last payment, if

these funds are taken from a pool that has been returning 10%

per year compounded quarterly?

Solution

PP = 6 months; CP = 3 months.

0.05 2

i= 1+ − 1 = 0.05063.

2

= 500(F/A, 5.063%, 14) = $9, 842.

Type 3: PP < CP; Case 1

of Type 2 by finding the effective interest rate per PP. Different

from Type 2, we cannot apply the relation of the nominal and

effective interest rates in (NOM-EFF) directly. The detailed

treatment can refer to Example 4.18 below.

Example 4.18

retirement plan that pays interest at a rate of 10% per year

compounded quarterly. Compute the balance at the end of 10

years.

Solution

PP = 1 month; CP = 3 months.

10% 1/3

i= 1+ − 1 = 0.826%

4

$500(F/A, 0.826%, 120) = $101, 907.89.

Type 3: PP < CP; Case 2

In this case,

Deposits (negative cash flows) are all regarded as

deposited at the end of the compounding period.

Withdrawals (positive cash flows) are all regarded as

withdrawn at the beginning of the compounding period.

Example 4.19

during a quarter (the compounding period) will not earn any

interest. Compute the balance at the end of 10 years.

Solution

Months

0 3 6 … 120

A = $500

Quarters

0 1 2 … 39 40

A = $1,500

Solution

4 = 2.5%.

A = 3($500) = $1, 500 per quarter.

So,

F = $1, 500(F/A, 2.5%, 40) = $101, 103.83.

- Chapter 02Uploaded byQuangnd
- Bahasa Inggris Bisnis Economic VocabularyUploaded byenday ridwan
- Final Examination Gen Math Sy 2018-2019Uploaded byJenalyn Cardano
- DK5739_CH6Uploaded byÖzer Ökten
- 3. Chapter 3 part 1Uploaded byEdward Zhao
- SPreCalc7_04_01 (1)Uploaded byShay
- Equations on Ti 86Uploaded bystefano
- Solution TVMUploaded byMohammad Nabil Abdullah
- Chapter 2 part 1.pptUploaded byRaphael Razon
- UNIT IIUploaded byAnonymous DQGLUZxH
- showaibs financial mathematics assignmentUploaded byapi-450894902
- Ch. 2 Problems JoinedUploaded byNazmulAhsan
- ECON430 SolutionUploaded byالاشقر اليامي
- Lecture 8 9Uploaded bysalmanshahidkhan
- Economics(shifted series)Uploaded byapi-26367767
- IMTG_ACES.pptxUploaded bybrain_mania
- Part 3. Usury LawUploaded byCid Benedict Pabalan
- Demonetization through segmented marketsUploaded byParag Waknis
- RealWorldGraduation Question 34 Sound InvestmentsUploaded byEdward D Duvall
- Retire Rich Retire YoungUploaded byVishal Thakkar
- Direct Loans: Subsidy ReestimatesUploaded byAaron Monk
- EMI_CalculatorUploaded bymurugesh18
- 702221.pdfUploaded byGuna Seelan
- The Secret Trading ReportUploaded bysergiocharlin
- Outline 1Uploaded bywtk2010
- Prorate InterestUploaded byglnritchie
- 10. CBTCUploaded byJem Jem
- Santiago GloriaUploaded byJoel Reyes
- Credit Mind MapUploaded byalexis_bea
- Calculator LoanUploaded byRavi Venkat

- Heat Treat TiUploaded byWo Kit Lam
- 747Uploaded byWo Kit Lam
- Alpha Case Prevention-FinalUploaded byleonardocelotto
- scheme AUploaded byWo Kit Lam
- NowUploaded byWo Kit Lam
- Sherlock.docxUploaded byWo Kit Lam
- Photo LithographyUploaded byWo Kit Lam
- ScriptUploaded byWo Kit Lam
- 3050Uploaded byWo Kit Lam
- Final ScriptUploaded byWo Kit Lam
- 複習答案卷Uploaded byWo Kit Lam
- Message Box TemplateUploaded byWo Kit Lam
- CrimeUploaded byWo Kit Lam
- assig5_2010Uploaded byWo Kit Lam
- Relative CluaseUploaded byWo Kit Lam

- intenal assesment-3Uploaded bychandumicrocosm1986
- Distinguishing MERS v Azize and RevoredoUploaded bysonjascribd
- IBAN-enUploaded byKabalan Boujaoude
- Sbi ChallanUploaded byanaga1982
- EbankingUploaded byatulmani
- Assignment of Financial InstitutionUploaded byKamalpreet_Mad_6500
- Statement 2710201701575611Uploaded byRohit Sunil Deshmukh
- Ch4Uploaded byspicegyal
- International EconomicsUploaded byBill Benntt
- UCP 600.docUploaded byaryoooiiiii
- Math7 Converting Currencies .pdfUploaded byaikenike
- Installment Sales SoalUploaded byFaisal
- India Rupee Exchange Rate of Foreign Currency for Import and ExportUploaded byJhunjhunwalas Digital Finance & Business Info Library
- Financial ManagementUploaded byozalmistry
- Value Based Current Accounts Schedule of ChargesUploaded byDhawan Sandeep
- 335469444-credit-pdfUploaded byHanna
- All Types of Business LetterUploaded byHimadri Himu
- The Federal Reserve System & Monetary PolicyUploaded byanon-583057
- Ratio Analysis of Axis BankUploaded bySukhchain Aggarwal
- VP Operational Risk Manager in Jacksonville FL Resume Amy Lyn MorroUploaded byAmyLynMorro
- 3500145 Financial Math for Actuary and BusinessmanUploaded byavcy
- Challan FormUploaded byoptimist_24
- Digest Compilation 5.B-Bills, Notes and Commercial Papers _ May 4, 2016Uploaded byKevin Hernandez
- Syllabus - Credit Transactions (2014)Uploaded byIvoryAthenaPalarcaPospos
- NMATUploaded byAjeet Singh Rachhoya
- Chapter 8-1.pdfUploaded bykingme157
- Personal Loans and Financing in FullertonfinalUploaded byvipultandonddn
- Cash and Cash EquivalentsUploaded byAngela Jane Santos
- DBS LoanUploaded byOnaFajardo
- Act 519 Central Bank of Malaysia Act 1958Uploaded byAdam Haida & Co