1

Time value of money

The value of money changes overtime because of the interest rate. The interest
rate is the factor which differentiate present value and future value. The interest
rare includes inflation, liquidity, maturity and default ratio. In time value of money
analysis, we calculate the present value and future value in 3 cases.
i) Lumpsum cases
ii) Annuity cases
iii) Multiple cash flow cases
Lumpsum cases: In this case, we calculate the present value and future value for a
single amount.
𝐹𝑉 = 𝑃𝑉 (1 + 𝑟)𝑛
Where,
F.V. = future value
P.V.= present value
r = interest rate
n = no. of period
E.G,
❖ Suppose that you just deposited Rs. 200 for 200 years at an interest rate of
8%. Calculate FV at the end of 200 years.
Solution,
𝐹𝑉 = 𝑃𝑉 (1 + 𝑟)𝑛
=200(1+0.08)200
= 967789917
Annuities cases: annuities are the series of payment or receipts for the specifics
time period. The payment or received must be in equal interval. There are 2 types
of annuities.
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a) Ordinary annuities
b) Annuities due
If the payment or received are being made at the end of the period then they are
ordinary annuities. And if the payment or received are being made from the
beginning or immediately then they are annuities due.
For ordinary annuities
1
{ }
(1 + 𝑟)𝑛
𝑃𝑉𝐴 = 𝐴 [1 − ]
𝑟

{(1 + 𝑟)𝑛 − 1}
𝐹𝑉𝐴 = 𝐴 [ ]
𝑟
For annuities due
1
{ }
(1 + 𝑟)𝑛
𝑃𝑉𝐴 = 𝐴 [1 − ] ∗ (1 + 𝑟)
𝑟

{(1 + 𝑟)𝑛 − 1}
𝐹𝑉𝐴 = 𝐴 [ ] ∗ (1 + 𝑟)
𝑟

E.G,
❖ Suppose that you will received Rs. 100 per years for next 5 years stating
today. If the relevant interest rate is 10% then calculate the present value of
annuities due.
Solution,
1
{ }
(1 + 𝑟)𝑛
𝑃𝑉𝐴 = 𝐴 [1 − ] ∗ (1 + 𝑟)
𝑟

1
{ }
(1 + 0.10)5
𝑃𝑉𝐴 = 100 [1 − ] ∗ (1 + 0.10)
0.10

= 416.9865
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❖ Suppose that you will be received Rs. 10000 per years for next 5 years stating
6 years. If the interest rate is 10% then calculate the present value.
Solution,

1
{ }
(1 + 𝑟)𝑛
𝑃𝑉𝐴 = 𝐴 [1 − ]
𝑟

1 1
{(1+0.10)10 } { }
(1+0.10)5
𝑃𝑉𝐴 = 10000 [1 − 𝑟0.10
] - [1 − 0.10
]

= 10000 (6.1446-3.7908)

= 23538.1323

Note: the PV and FV of annuities due is always higher than ordinary

annuities. If the question is silent then we always assume ordinary annuities.
Multiple cash flow cases: it is the mix of lumpsum and annuities. It can be
illustrated as follows,
❖ Suppose that you just deposite Rs. 15000 in siddhart bank and you expect to
make additional deposite od 20000, 30000, and 40000 in year 3, 5 and 6
respectively. Calculate the total value at the end of 8 years and also calculate
the present value if the interest rate is 10%.
Solution,

Determination of interest rate and no. of period.

❖ In how many years will it take to double your money. If the intrest rate is (a)
0%, (b) 100%, (c) 9.5%.
Solution,
(a). r = 0%,
At 0% interest rate PV and FV are same. So, money will never double.
(b). r = 100%
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Double in 1 year.
© r = 9.5%
Now,
FV = PV(1+r)^n
2x = x (1+0.095)^n
Taking log both side,
n log 1.095 = log 2
n * 0.0394 = 0.3
n = 7.64
❖ If you want to accumulate Rs. 1000000 in 8 years. You currently have Rs.
300000 in a bank account. At what equilibrium at interest rate your goal will
be fulfilled.
Solution,

Compounding period
The compounding period means interest calculation period and it may be annually,
sem-annually, quarterly and soon. Due to higher compounding period the investors
rate of return is higher the quate rate or annual percentage rate (APR). the actual
rate of return earned by investor is called effective annual rate.
EAR = (1+PR)M-1
Where,
EAR = effective annual rate
PR = periodic period
M= no. of compounding period
If the compounding period is continuous then effective annual rate can be
calculated as follows,
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EAR = eq-1
Where,
q = interest rate
for example,
when r = 10% then
EAR =( eq-1) = (e0.10-1) = 10.517

Perpetuity: the annuity that goes forever is called perpetuity. The present value of
perpetuity can be calculated as follows;
A
PVP =
r

Where,
A = annuities
PVP = present value of perpetuity
r = interest rate
Growing perpetuity: the annuities that grow at constant rate forever is called
growing perpetuity. The present value of growing perpetuity can be calculated as;
CF1
PV =
r−g

Where,
C.F1 = cash flow in year 1
r = interest rate
g = growing rate

Growing annuities: annuities that grow at constant rate for specific time period is
called growing annuities. The present values of growing annuities can be calculated
as follows,
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1+g n
{ }
1+r
PV = CF1[1 − ]
r−g

Where,
C.F1 = cash flow in year 1
r = interest rate
g = growing rate

Amortize loan: amortize loan are that type of loan which is periodically amortized
for specific time period. The periodically installment consists loan principal and
interest.
Periodical installment,
𝑙𝑜𝑎𝑛 𝑎𝑚𝑜𝑢𝑛𝑡
𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 = 1
{1− }
(1+𝑟)𝑛
[ ]
𝑟

E.G,
Loan amount = 12000000
r = 12%/12 = 1% monthly
n = 15 years *12 180 period
monthly installment = ?
Now,
12000000
𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 = 1 = 144020.17=144020
{1− }
(1.01)180
[ ]
0.01

❖ Loan amount = 500000

n = 3 years , r = 12%
Annual installment = ?
Prepare amortization schedule
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𝑙𝑜𝑎𝑛 𝑎𝑚𝑜𝑢𝑛𝑡
𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 =
1
{1 − }
(1 + 𝑟)𝑛
[ 𝑟 ]

500000
𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐𝑎𝑙 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 =
1
{1 − }
(1.12)3
[ ]
0.12

= 208174.5

Amortization schedule
Periods Installment Interest rate Principle Balance
payment principle
1 208174.5 500000*0.12 = 208174.5- 500000-
60000 60000 = 148174.5 =
148174.5 351825.5
2 208174.5 351825.5*0.12 = 201874.5- 351825.5-
42219.06 42219.06 = 165955.44 =
165955.44 185870.06
3 208174.5 185870.06*0.12 208174.50- 0.03
= 22304.41 22304.41 =
185870.09
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Bond valuation

Concept of bond and its features

Bond is the contract between two parties in which one party agree to provide loan
and another party agree to make promise payment in the future. It can be issued
by the government or by the organization to fulfill long term requirement of the
fund. Some features of bond are,
i. Par value or face value or maturity value
ii. Maturity period
iii. Coupon amount
iv. Sinking fund provision
v. Bond indenture/contract
vi. Call provision
vii. Convertible provision
viii. Warrant provision
ix. No voting rights
Valuation of bond
Types of bond
i. Redeemable bond
ii. Irredeemable bond
iii. Zero coupon bond
The redeemable bond has a fixed maturity period and it provides periodically cash
flow (interest amount) for specific time period and maturity value at the end of
maturity.
The irredeemable bond does not have fixed maturity and it provides periodically
cash flow forever. This bond is also called perpetual bond or consul bond.
Zero coupon bond are pure discount bond i.e. they issue at discount and redeem
at par.
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Valuation means determination of price of the security, on the basis of future cash
flow. Value of bond today is the present of future cash flow provided by the bond.
Value of each bond
For redeemable bond, v0
1
{ } 1
(1 + 𝑌𝑇𝑀)𝑛
𝐯0 = 𝐼 [1 − ] + 𝑀{ }
𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

Where,
V0 = current price of bond or current intrinsic value of bond or current value
of bond
I = interest amount (face value * coupon rate)
n = maturity period
YTM = yield to maturity or market rate or discount rate or required rate or
going rate
M = face value or par value or maturity value
For irredeemable bond (perpetual bond),
𝐼
𝑉0 =
𝑌𝑇𝑀

For zero coupon bond,

𝑀
𝑉0 =
(1 + 𝑌𝑇𝑀)𝑛
Characteristics of bond value
a. When CR = YTM then V0 = M.
b. When CR > YTM then V0 > M.
c. When CR < YTM then V0 < M.
d. Value of bond changes as changes in maturity.
i. When CR = YTM then V0 = M at maturity.
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ii. When CR > YTM then value of bond decreases as decrease in maturity
until that touch’s maturity value at the end of maturity and viceverca.
y

CR>YTM, V0>M CR=YTM, V0=M

(premium bond) (par bond)

Value
of
bond

CR<YTM, V0<M
(discount bond)

0 x
Maturity period