Quant: Lecture 2

FV, PV, and Annuities

• Reference:
• Textbook – Reading 6

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 NO HOMEWORK = 0 MAXIMUM (10 MARKS)
MARK
Homework
review

STUDENTS MUST HAVE A STUDENTS MUST JOIN

FINANCIAL CALCULATOR THE HANGOUT
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Warm-up 1: Using financial calculator

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 - Other than BA Two Plus
calculator will not be allowed in
the class.

Warm-up 2:
Make these calculations below
Using using Financial calculator:
financial
• 2.5 * 2 + 1.2 =
calculator • (How to change the number of decimal
places?)
•1+2*3=
• (How to turn on the AOS mode - Algebraic
Operating System?)
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 ▪ (1 + 3)^ 2 =
Warm-up 3: ▪ (1 + 5%) ^ 3 =
Using ▪ (1 – 8%) ^ 2 =
▪ 5 ∗ 30 =
financial 3
▪ 61.4/7 =
calculator 1
▪ =
(1+10%)2
1.1 Future value and Future value is the amount to which a current
deposit will grow over time when it is placed in
Present value an account paying compound interest.

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1.2 Future value and Present value
Example 1: Future value
Calculate the FV of a $200 investment at the end of two
years if it earns an annually compounded rate of return
of 10%.

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1.3 Future value and Present value
The present value of a single sum is today’s value of a
cash flow that is to be received at some point in the
future.

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1.4 Future value and Present value
Example 2: Present value
Given a discount rate of 10%, calculate the PV of a $200
cash flow that will be received in two years.

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 An annuity is a stream of equal
cash flows that occurs at equal
intervals over a given period.
2.1 Annuities
Example 3: Receiving $1,000 per
year at the end of each of the next
eight years.
 The ordinary annuity: cash
flows that occur at the end of
each compounding period.
2.2 Annuities
The annuity due: payments or
receipts occur at the beginning
of each period (i.e., the first
payment is today at t = 0).

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 Example 4:
An ordinary annuity that pays $200
per year at the end of each of the next
three years, given the investment is
expected to earn a 10% rate of return.
2.3 Annuities
i. Draw the timeline
ii. Show the formula of and calculate
future value
iii. Show the formula of and calculate
present value
 Example 5: Present value of
ordinary annuity
What is the present value of an
2.4 Annuities ordinary annuity that pays $200
per year at the end of each of
the next three years, given the
investment is expected to earn
a 10% rate of return?
 Example 6: Present value of
ordinary annuity (cont.)
What is the present value of four
2.5 Annuities $100 end-of-year payments if the
first payment is to be received
three years from today and the
appropriate rate of return is 9%?
 Example 7: Present value of a
bond’s cash flows
A bond will make coupon interest
payments of $70 (7% of its face
value) at the end of each year and
2.6 Annuities will also pay its face value of
$1,000 at maturity in six years. If
the appropriate discount rate is 8%,
what is the present value of the
bond’s promised cash flows?
 Example 8: Present value of an
annuity due
Given a discount rate of 10%, what
2.7 Annuities is the present value of an annuity
that makes $200 payments at the
beginning of each of the next three
years, starting today?
 Example 9: Annuity due vs.
Ordinary annuity
What is the present value of
2.8 Annuities three $100 payments, given
discount rate is 8%? Assume:
• Ordinary annuity: PV =
• Annuity due: PV =
3.1 Perpetuity
A perpetuity is a financial instrument that pays a fixed
amount of money at set intervals over an infinite period
of time.

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 Example 10: A company issues
preferred stock that will pay $4.50
per year in annual dividends
3.2 beginning next year and plans to
Perpetuity follow this dividend policy forever.
Given an 8% rate of return, what is
the value of the preferred stock
today?
 Example 11: Using a rate of return
of 10%, compute the future value of
the three-year uneven cash flow
stream described below at the end
of the third year.
4. Uneven
cash flows

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 HOMEWORK
Question 1: How much must be invested today, at 8%
interest, to accumulate enough to retire a $10,000 debt
due seven years from today?

Question 2: An investor has just won the lottery and will

receive $50,000 per year at the end of each of the next
20 years. At a 10% interest rate, what is the present
value of the winnings?

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 HOMEWORK
Question 3. An investor is to receive a 15-year, $8,000 annuity, with the
first payment to be received today. At an 11% discount rate, what is the
present value of this annuity?

Question 4. A preferred stock is expected to pay a $9 annual dividend

forever. If the required rate of return on equivalent investments is 11%,
what is its price?

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