Time Value of Money

EXAM FM - A Comprehensive List of Formulas

Effective Interest Rate: 𝑖𝑖𝑡𝑡 =

Simple Interest: 𝑎𝑎(𝑡𝑡) = 1 + 𝑖𝑖𝑖𝑖

EXAM FM
Accumulation and Amount Function: 𝐴𝐴(𝑡𝑡) = 𝐾𝐾𝐾𝐾(𝑡𝑡) 𝐴𝐴(0) = 𝐾𝐾 𝑎𝑎(0) = 1
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡−1)

𝑖𝑖𝑡𝑡 =
=
𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)

𝑖𝑖
𝐴𝐴(𝑡𝑡−1)

FORMULA CARD
Force

Const
PV of
EXAM FM
- -A--AComprehensive
AComprehensive
Comprehensive List of Formulas
1+𝑖𝑖(𝑡𝑡−1)
EXAM
EXAM
EXAMFMFM
FM A Comprehensive List
List
List of
ofof Formulas
Formulas
Formulas (1 + 𝑖𝑖)𝑡𝑡
𝑃𝑃𝑃𝑃 =
TIME VALUE Compound
OF MONEY Interest: 𝑎𝑎(𝑡𝑡) = 𝑖𝑖𝑡𝑡 = 𝑖𝑖 𝑎𝑎
Time Value of Money 𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1) 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
AV of
Time
Time
Time
Time Value
Value
Value
Value ofMoney
of Money
Money
ofofMoney Effective Discount Rate: 𝑑𝑑 =𝐴𝐴′ (𝑡𝑡)
𝑎𝑎′ (𝑡𝑡)𝑡𝑡 𝑎𝑎(𝑡𝑡)
= 𝑡𝑡
𝐴𝐴(𝑡𝑡)
∫0 𝛿𝛿𝑟𝑟 𝑑𝑑𝑑𝑑
𝑡𝑡
∫0 𝛿𝛿𝑟𝑟 𝑑𝑑𝑑𝑑
Accumulation and Amount Function: 𝐴𝐴(𝑡𝑡) = 𝐾𝐾𝐾𝐾(𝑡𝑡) 𝐴𝐴(0) = 𝐾𝐾 𝑎𝑎(0) = 1 Force of Interest: 𝛿𝛿𝑎𝑎𝑡𝑡 ′(𝑡𝑡) = ′ ′
(𝑡𝑡)
𝑎𝑎 𝑎𝑎
′ (𝑡𝑡)
𝑎𝑎𝑎𝑎(𝑡𝑡)
(𝑡𝑡) ′ =
𝐴𝐴 (𝑡𝑡)′ ′
(𝑡𝑡)
𝐴𝐴 𝐴𝐴
′ (𝑡𝑡)
𝐴𝐴𝐴𝐴(𝑡𝑡)
(𝑡𝑡)
𝑎𝑎(𝑡𝑡) =𝑡𝑡 𝑒𝑒 𝑡𝑡 𝑡𝑡𝑡𝑡 𝐴𝐴(𝑡𝑡) = 𝐴𝐴(0)𝑒𝑒
𝑡𝑡 𝑡𝑡 𝑡𝑡𝑡𝑡
∫ 𝛿𝛿 𝑑𝑑𝑑𝑑 ∫ 𝑑𝑑𝑑𝑑
𝛿𝛿𝑟𝑟𝑟𝑟𝑑𝑑𝑑𝑑
Accumulation
Accumulation
Accumulation
Accumulation and and
and
and Amount
Amount
Amount
Amount Function:
Function:
Function:
Function: 𝐴𝐴(𝑡𝑡)𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡)
= = =
= 𝐾𝐾𝐾𝐾(𝑡𝑡)
𝐾𝐾𝐾𝐾(𝑡𝑡)
𝐾𝐾𝐾𝐾(𝑡𝑡)
𝐾𝐾𝐾𝐾(𝑡𝑡)𝐴𝐴(0) 𝐴𝐴(0)
𝐴𝐴(0)
𝐴𝐴(0)== =
𝐾𝐾= 𝐾𝐾 𝑎𝑎(0)
𝐾𝐾𝐾𝐾
𝑎𝑎(0) 𝑎𝑎(0)
𝑎𝑎(0)
==1==
1 11 Force
Force
Force
Forceofofof
of
Discount Interest:
Interest:
Interest:
Interest: =𝛿𝛿=
𝑡𝑡𝛿𝛿
Rate:𝛿𝛿𝑡𝑡𝑑𝑑𝛿𝛿= ==
𝑖𝑖 = ==
𝑡𝑡𝑡𝑡𝑎𝑎(𝑡𝑡) = =
1𝐴𝐴(𝑡𝑡)
−𝐴𝐴(𝑡𝑡) =𝑎𝑎(𝑡𝑡)
𝑣𝑣𝐴𝐴(𝑡𝑡) 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑖𝑖𝑖𝑖𝑎𝑎(𝑡𝑡)=𝑣𝑣= =
𝑒𝑒=∫= 𝛿𝛿
∫
0𝑒𝑒 𝑒𝑒 𝑟𝑟
0
(1
𝑑𝑑𝑑𝑑
∫𝛿𝛿 𝛿𝛿
𝑒𝑒 00𝑟𝑟+ 𝑖𝑖)
𝑑𝑑𝑑𝑑
𝑟𝑟
𝑟𝑟 𝑑𝑑𝑑𝑑
𝐴𝐴(𝑡𝑡)
−1 𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡) == 1== 1𝐴𝐴(0)𝑒𝑒
𝐴𝐴(0)𝑒𝑒
−
∫
𝐴𝐴(0)𝑒𝑒
𝐴𝐴(0)𝑒𝑒
0 0
=1
𝛿𝛿
∫ 𝑟𝑟 00𝑟𝑟𝛿𝛿
𝑑𝑑𝑑𝑑
∫𝛿𝛿 𝑑𝑑𝑑𝑑 𝐴𝐴𝐴𝐴 = 𝑎𝑎
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1) 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1) 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡) 𝐴𝐴(𝑡𝑡)
Effective Interest Rate: 𝑖𝑖𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑡𝑡 = 𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
= 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
Constant Force of Interest: 1+𝑖𝑖 𝑒𝑒 𝛿𝛿 = 1 + 𝑖𝑖 𝛿𝛿 = ln(1 + 𝑖𝑖) 𝑑𝑑 𝑖𝑖
𝑎𝑎(𝑡𝑡−1) 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡−1)
Effective
Effective
Effective
Effective Interest
Interest
Interest
Interest Rate:
Rate:
Rate:
Rate: 𝑡𝑡 𝑖𝑖𝑖𝑖=
𝑖𝑖𝑡𝑡 𝑖𝑖= =
𝑡𝑡𝑡𝑡 = = == = Constant
Constant
Constant
Constant ForceForce
Force
Forceofof ofof
Interest: Interest:
Interest:
Interest: 𝑖𝑖 (𝑚𝑚) 𝑒𝑒 𝑒𝑒=
𝛿𝛿
𝑚𝑚𝛿𝛿 𝛿𝛿𝑒𝑒𝑒𝑒𝛿𝛿=
1= =1 1+
+ 𝑖𝑖1+ +
𝑖𝑖 𝑖𝑖𝑖𝑖𝛿𝛿 = 𝛿𝛿ln=
𝛿𝛿 𝛿𝛿= =lnln
(1 ln
(1 +(1 (1𝑖𝑖)+
+ +
𝑖𝑖) 𝑖𝑖) 𝑚𝑚
𝑖𝑖)
𝑑𝑑 (𝑚𝑚)
𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡−1) 𝐴𝐴(𝑡𝑡−1)
𝑖𝑖𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡−1) Nominal
PV of $1Rates: due in (1 𝒕𝒕 years:
+ ) = 1 + 𝑖𝑖 (1 − ) = 1 − 𝑑𝑑 AV at
Simple Interest: 𝑎𝑎(𝑡𝑡) = 1 + 𝑖𝑖𝑖𝑖 𝑖𝑖𝑡𝑡 =𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖 PVPV PV
PV
of of of
of
$1 $1 $1
$1
due due
due 𝒕𝒕in in years:
𝒕𝒕 years: 𝑚𝑚 𝑚𝑚
Simple
Simple
Simple
Simple Interest:
Interest:
Interest:
Interest: 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
== 1= =
+1 1+1+
𝑖𝑖𝑖𝑖 +𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑖𝑖𝑡𝑡 𝑖𝑖=𝑡𝑡 𝑖𝑖𝑖𝑖= = 1+𝑖𝑖(𝑡𝑡−1)
𝑡𝑡𝑡𝑡 =
1due inin years:
𝒕𝒕 𝒕𝒕years:
(𝑚𝑚)
1
(𝑚𝑚) 𝑖𝑖 (𝑚𝑚) −𝑚𝑚𝑚𝑚
(1
1𝑑𝑑 (𝑚𝑚) 𝑚𝑚𝑚𝑚
1+𝑖𝑖(𝑡𝑡−1)
1+𝑖𝑖(𝑡𝑡−1)
𝑡𝑡1+𝑖𝑖(𝑡𝑡−1)
1+𝑖𝑖(𝑡𝑡−1) 𝑃𝑃𝑃𝑃 1=1 11 = (1 +𝑖𝑖 𝑖𝑖)−𝑡𝑡==𝑚𝑚𝑣𝑣 𝑡𝑡[(1 =+ 𝑖𝑖)𝑚𝑚=−(1
𝑒𝑒 −𝛿𝛿𝛿𝛿 1]− 𝑑𝑑)𝑡𝑡 = 𝑑𝑑 (1 +
(𝑚𝑚) =
(𝑚𝑚)
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖
𝑚𝑚
−𝑚𝑚𝑚𝑚
(𝑚𝑚)
(𝑚𝑚) −𝑚𝑚𝑚𝑚
) [1 −𝑚𝑚𝑚𝑚
−𝑚𝑚𝑚𝑚 − = −
(1 𝑑𝑑)
− ](𝑚𝑚)
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑𝑚𝑚 )
(𝑚𝑚)
(𝑚𝑚)
𝑚𝑚𝑚𝑚
𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚
𝑚𝑚(𝑚𝑚)
Metho
Compound Interest: 𝑎𝑎(𝑡𝑡) = + 𝑖𝑖) (1 𝑖𝑖𝑡𝑡 = 𝑖𝑖 𝑃𝑃𝑃𝑃
𝑃𝑃𝑃𝑃
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
= == = 𝑎𝑎(𝑡𝑡)
== (1==(1+(1 (1+𝑖𝑖)++
−𝑡𝑡 𝑖𝑖)
𝑖𝑖)𝑖𝑖) −𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡𝑡𝑡 −𝛿𝛿𝛿𝛿−𝛿𝛿𝛿𝛿
=−𝑡𝑡
−𝑡𝑡
=𝑣𝑣= =𝑣𝑣=𝑣𝑣𝑣𝑣= 𝑒𝑒= = = −𝛿𝛿𝛿𝛿
𝑒𝑒 𝑒𝑒𝑒𝑒−𝛿𝛿𝛿𝛿 =(1= =(1 −(1 (1−𝑑𝑑)− − 𝑡𝑡 𝑑𝑑)
𝑑𝑑) =𝑡𝑡 =
𝑑𝑑) 𝑡𝑡𝑡𝑡 = (1 + 𝑚𝑚 )
(1 =(1 + (1++ ) ) ) = = (1 ==
(1− (1
(1 −− − ) ) ))
𝑡𝑡
Compound
Compound
Compound
Compound Interest:
Interest:
Interest:
Interest: 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
== (1=(1= +(1+ (1𝑖𝑖)+ +
𝑡𝑡 𝑖𝑖)
𝑡𝑡 𝑡𝑡 𝑖𝑖
𝑖𝑖)𝑖𝑖) 𝑖𝑖𝑡𝑡 𝑖𝑖=𝑡𝑡 𝑖𝑖=𝑡𝑡𝑖𝑖𝑡𝑡 == 𝑖𝑖𝑖𝑖
𝑖𝑖 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1) 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡) 𝑚𝑚 𝑚𝑚𝑚𝑚 𝑚𝑚 𝑚𝑚 𝑚𝑚𝑚𝑚𝑚𝑚
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
Effective Discount Rate: 𝑑𝑑𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1) 𝑡𝑡 = = AV of $1 over 𝒕𝒕 years:
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1) 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
Effective
Effective
Effective
Effective Discount
Discount
Discount
Discount Rate: Rate:
Rate:
Rate: 𝑑𝑑𝑡𝑡𝑑𝑑= 𝑑𝑑=
𝑡𝑡𝑑𝑑 𝑡𝑡𝑡𝑡 = = 𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡)−𝑎𝑎(𝑡𝑡−1)
𝑎𝑎(𝑡𝑡) 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
= == = 𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡)−𝐴𝐴(𝑡𝑡−1)
𝐴𝐴(𝑡𝑡)
AV AV AV
AV
of of of
of
Annuities
$1 $1 $1$1
over over
over
over 𝒕𝒕 years: years:
𝒕𝒕 years:
𝒕𝒕 𝒕𝒕years: 𝑖𝑖 (𝑚𝑚)
𝑚𝑚𝑚𝑚
𝑑𝑑 (𝑚𝑚)
−𝑚𝑚𝑚𝑚
𝑎𝑎(𝑡𝑡) 𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡) 𝐴𝐴(𝑡𝑡) 𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡)
𝐴𝐴(𝑡𝑡) 𝑚𝑚𝑚𝑚 −𝑚𝑚𝑚𝑚
𝑖𝑖
Discount Rate: 𝑑𝑑𝑖𝑖 =𝑖𝑖 𝑖𝑖𝑖𝑖 = 1 − 𝑣𝑣 = 𝑖𝑖𝑖𝑖 𝑣𝑣 = + 𝑖𝑖)−11 1 111 −
(1
1 1
=1 𝐴𝐴𝐴𝐴 = 𝑎𝑎(𝑡𝑡) = (1 + 𝑖𝑖)𝑡𝑡 = 𝑒𝑒 𝛿𝛿𝛿𝛿 = (1 − 𝑑𝑑)−𝑡𝑡 = (1 𝑖𝑖 +
(𝑚𝑚)
𝑖𝑖 𝑖𝑖
(𝑚𝑚)
𝑖𝑖 (𝑚𝑚)
(𝑚𝑚) )𝑚𝑚𝑚𝑚
𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 = (1 𝑑𝑑 −
(𝑚𝑚)
𝑑𝑑 𝑑𝑑
−𝑚𝑚𝑚𝑚
(𝑚𝑚)
(𝑚𝑚)
(𝑚𝑚)
𝑑𝑑 )−𝑚𝑚𝑚𝑚
−𝑚𝑚𝑚𝑚

Discount Rate: 𝑑𝑑 = 1+𝑖𝑖

= 1 − 𝑣𝑣 = 𝑖𝑖𝑖𝑖 𝑣𝑣 = (1 + 𝑖𝑖) −1 𝑑𝑑 1 11𝑖𝑖
− = 𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
= = ==
𝑎𝑎(𝑡𝑡)𝑎𝑎(𝑡𝑡)
Annuity-Immediate:
𝑎𝑎(𝑡𝑡)
𝑎𝑎(𝑡𝑡)== (1==(1+(1 (1+𝑖𝑖)+𝑡𝑡+ 𝑡𝑡𝑖𝑖)𝑡𝑡𝑡𝑡 𝛿𝛿𝛿𝛿
𝑖𝑖)=𝑖𝑖)= 𝑒𝑒= = 𝑒𝑒𝛿𝛿𝛿𝛿𝛿𝛿𝛿𝛿
𝑒𝑒 𝛿𝛿𝛿𝛿
𝑒𝑒= = (1= =
(1 −(1 (1𝑑𝑑)−
− − −𝑡𝑡𝑑𝑑)
𝑑𝑑) 𝑑𝑑) =−𝑡𝑡
−𝑡𝑡−𝑡𝑡
=(1 = = (1 + (1
(1 ++ + )𝑚𝑚) ))= = (1 =
= (1 −(1 (1 −− − )𝑚𝑚) )) Decre
Discount
Discount
DiscountRate:Rate:
Rate: =𝑑𝑑== =1+𝑖𝑖
𝑑𝑑 𝑑𝑑 = 1=−1 1− 𝑣𝑣−= 𝑣𝑣 𝑣𝑣=𝑖𝑖𝑖𝑖=𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑣𝑣 = 𝑣𝑣 𝑣𝑣= (1=(1 +(1+ −1 −1
𝑖𝑖)+𝑖𝑖)𝑖𝑖) −1
−− −
== 1 11
1𝑖𝑖 = 𝑚𝑚 𝑚𝑚𝑚𝑚 𝑚𝑚 𝑚𝑚 𝑚𝑚𝑚𝑚 𝑚𝑚
1+𝑖𝑖1+𝑖𝑖 1+𝑖𝑖
𝑖𝑖 (𝑚𝑚)
𝑚𝑚 𝑑𝑑 𝑑𝑑 𝑑𝑑 𝑑𝑑𝑖𝑖𝑚𝑚 𝑖𝑖 𝑖𝑖
𝑑𝑑 (𝑚𝑚) (PV one period before first payment, AV at time of
𝑎𝑎(𝑡𝑡last
2)
payment) 𝑡𝑡
∫𝑡𝑡 2 𝛿𝛿𝑡𝑡 𝑑𝑑𝑑𝑑
Nominal Rates: (1 + 𝑚𝑚 𝑚𝑚)𝑚𝑚
(𝑚𝑚) 𝑚𝑚 = 1 + 𝑖𝑖 (1 − 𝑚𝑚 𝑚𝑚)𝑚𝑚
(𝑚𝑚) 𝑚𝑚 = 1 − 𝑑𝑑 AV at time 𝒕𝒕𝟐𝟐 of $1 invested at 1 − time 𝑣𝑣 𝑛𝑛 𝒕𝒕 : 𝐴𝐴𝐴𝐴 =
𝟏𝟏 ) = 𝑡𝑡2 𝑒𝑒 𝑡𝑡2 𝑡𝑡𝑡𝑡212 (𝐷𝐷𝐷𝐷)𝑛𝑛|
̅̅̅
𝑖𝑖 (𝑚𝑚) 𝑖𝑖𝑖𝑖(𝑚𝑚)
𝑖𝑖 (𝑚𝑚) 𝑑𝑑 (𝑚𝑚) 𝑑𝑑𝑑𝑑(𝑚𝑚)
𝑑𝑑 (𝑚𝑚) 𝑎𝑎(𝑡𝑡 )
) 2 )212 ∫ ∫𝛿𝛿∫ 𝑑𝑑𝑑𝑑
𝛿𝛿𝑡𝑡𝑡𝑡𝑑𝑑𝑑𝑑
Nominal
Nominal
Nominal
Nominal Rates:
Rates:
Rates:
Rates:(1(1+(1(1 + ++) ) = 𝑚𝑚
)) =1= =
+ 𝑖𝑖1+
1 1+ +𝑖𝑖 1𝑖𝑖𝑖𝑖 (1(1−(1(1 −
−(𝑚𝑚)−) 𝑚𝑚) = )) = 1= =
1 1−
− 1−
𝑑𝑑 −
𝑑𝑑 𝑑𝑑𝑑𝑑 1 AV AV AV
𝑃𝑃𝑃𝑃
AV
at at=at
at
time
timetime
𝑎𝑎time =𝒕𝒕of
̅̅̅𝒕𝒕𝟐𝟐
𝑛𝑛| 𝟐𝟐𝑣𝑣 𝟐𝟐+
𝒕𝒕𝒕𝒕𝟐𝟐of of
$1 of𝑣𝑣
$1
2
$1$1+
invested ⋯
invested + 𝑣𝑣 𝑛𝑛at=
invested
invested attime at
attime time
time 𝒕𝒕𝟏𝟏𝟏𝟏::𝐴𝐴𝐴𝐴
𝒕𝒕 :𝒕𝒕𝟏𝟏𝒕𝒕:𝐴𝐴𝐴𝐴 𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴
= == =2 𝑎𝑎(𝑡𝑡
𝑎𝑎(𝑡𝑡𝑎𝑎(𝑡𝑡
== 𝑒𝑒) == 𝑡𝑡𝑒𝑒
𝑡𝑡𝑒𝑒1 𝑒𝑒
∫𝑑𝑑𝑑𝑑
𝛿𝛿 𝛿𝛿
1𝑡𝑡𝑡𝑡𝑡𝑡11𝑡𝑡
𝑑𝑑𝑑𝑑

𝑖𝑖 (𝑚𝑚)
𝑚𝑚 𝑚𝑚𝑚𝑚 𝑚𝑚
= 𝑚𝑚 [(1 + 𝑚𝑚 𝑚𝑚𝑚𝑚 𝑚𝑚
= 𝑚𝑚 [1 − (1 −1 𝑑𝑑) 𝑖𝑖𝐴𝐴1𝟏𝟏𝑡𝑡1 +𝐴𝐴 𝑎𝑎(𝑡𝑡𝑎𝑎(𝑡𝑡 𝑎𝑎(𝑡𝑡
1 )𝑎𝑎(𝑡𝑡1 )11)
1 𝑖𝑖)1 1𝑚𝑚1 − 1] 𝑑𝑑 1]
1 1𝑚𝑚 2 𝑡𝑡2 +⋯+𝐴𝐴𝑛𝑛𝑛𝑛𝑡𝑡𝑛𝑛
(𝑚𝑚)
(𝑚𝑚) (𝑚𝑚)
(𝑚𝑚)
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖= = 𝑚𝑚= =𝑚𝑚 𝑚𝑚
𝑚𝑚
[(1 [(1 [(1
[(1
+ +
𝑖𝑖)+
+ 𝑖𝑖)𝑚𝑚𝑚𝑚
𝑖𝑖)𝑖𝑖)
− 1]−
− − 1]
1]1] (𝑚𝑚)(𝑚𝑚) (𝑚𝑚)
(𝑚𝑚)
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑= = 𝑚𝑚= = 𝑚𝑚
[1𝑚𝑚
𝑚𝑚 [1−[1[1
(1−
− −
(1 (1
−(1− −
𝑑𝑑)− ]𝑑𝑑)
𝑚𝑚𝑑𝑑)
𝑑𝑑) ]𝑚𝑚]] Method of Equated Time: 𝑡𝑡𝐴𝐴̅ = 𝐴𝐴𝐴𝐴 𝑡𝑡𝑛𝑛−1
+𝐴𝐴
(1
𝑡𝑡22+⋯+𝐴𝐴
+⋯+𝐴𝐴
+ 𝑖𝑖)𝑡𝑡𝑡𝑡 − 1
(𝐷𝐷𝑎𝑎̈ )𝑛𝑛|
1𝐴𝐴 111𝑡𝑡+𝐴𝐴 +𝐴𝐴 2𝑡𝑡+⋯+𝐴𝐴
+⋯+𝐴𝐴 𝑛𝑛
+ (1Time 𝑡𝑡(1 =𝑡𝑡+11+𝐴𝐴
𝑡𝑡𝑖𝑖) 1𝑡𝑡 +⋯+𝐴𝐴
𝑡𝑡22= 𝑛𝑛 𝑡𝑡𝑛𝑛 𝑡𝑡𝑛𝑛
𝑚𝑚𝑚𝑚 𝐴𝐴𝐴𝐴 =of𝑠𝑠𝑛𝑛| = 1Equated +Time𝑖𝑖)Time
+ :⋯ + = 𝑎𝑎𝑛𝑛| ̅̅̅ (1 + 𝑖𝑖)
𝑚𝑚 𝑚𝑚
Method Method
Method
Method of
̅̅̅ of
ofEquatedEquated
Equated Time :𝑡𝑡̅ ::=𝑡𝑡̅ 𝑡𝑡= ̅ ̅= 1𝐴𝐴
2 122+𝐴𝐴 2 𝑛𝑛𝑛𝑛 𝑛𝑛𝑛𝑛
𝑖𝑖
̅̅̅
𝐴𝐴1𝐴𝐴 +𝐴𝐴 1𝐴𝐴𝐴𝐴
+𝐴𝐴
1 +𝐴𝐴
21+𝐴𝐴
+⋯+𝐴𝐴
2 +⋯+𝐴𝐴 +⋯+𝐴𝐴
22+⋯+𝐴𝐴 𝑛𝑛 𝑛𝑛 𝑛𝑛𝑛𝑛
Annuity-Due: Increa
Annuities ANNUITIES
(PV at time of first payment, AV one period after last payment)
Annuities
Annuities
Annuities
Annuities 1 − 𝑣𝑣 𝑛𝑛 𝑖𝑖 (𝐼𝐼𝐼𝐼)∞|
Annuity-Immediate: Decreasing
𝑃𝑃𝑃𝑃 ̅̅̅ = 1 + Annuity
= 𝑎𝑎̈ 𝑛𝑛| - Payments
𝑣𝑣 + ⋯ + 𝑣𝑣 𝑛𝑛−1 = =in( Arithmetic Progression:
̅̅̅ = (1 + 𝑖𝑖)𝑎𝑎
) 𝑎𝑎𝑛𝑛| ̅̅̅ = 1 + 𝑎𝑎𝑛𝑛−1|
𝑛𝑛| ̅̅̅̅̅̅̅
̅̅̅̅
Annuity-Immediate:
Annuity-Immediate:
Annuity-Immediate:
Annuity-Immediate:
(PV one period before first payment, AV at time of last payment) Decreasing Annuity
Decreasing
Decreasing
Decreasing Annuity -- Payments 𝑑𝑑
Payments in 𝑑𝑑Arithmetic
in Arithmetic
Annuity
𝑛𝑛 Annuity Progression:
Progression:
̅̅̅ - Payments - Payments in in Arithmetic
Arithmetic −Progression:
1Progression:
𝑛𝑛
− 𝑎𝑎𝑛𝑛|
𝑛𝑛 𝑛𝑛(1 + 𝑖𝑖)
(1 +− 𝑖𝑖) 𝑠𝑠𝑛𝑛|
̅̅̅ 𝑖𝑖
(PV(PV (PV
(PV
oneone one
one
period period
period
period before before
before
before first first
first
first payment,
payment,
payment,
payment, 1− AV 𝑛𝑛AV at time of last payment)
𝑣𝑣AVAV
at at attime
time timeof oflastoflastlast payment)
payment)
payment) (𝐷𝐷𝐷𝐷)
𝐴𝐴𝐴𝐴 = 𝑠𝑠̈𝑛𝑛| ̅̅̅ =
𝑛𝑛
̅̅̅ −𝑛𝑛 𝑛𝑛(1
= − 𝑛𝑛
𝑎𝑎̅̅̅− −
𝑎𝑎
+̅̅̅ 𝑎𝑎𝑛𝑛|
𝑎𝑎𝑖𝑖) + (1 + 𝑖𝑖)(𝐷𝐷𝐷𝐷)
̅̅̅
̅̅̅
𝑛𝑛|
2
+ ⋯𝑛𝑛| +
̅̅̅𝑛𝑛(1 =
(1𝑛𝑛(1 +𝑛𝑛(1
𝑛𝑛(1
+𝑖𝑖)+ 𝑖𝑖)𝑛𝑛+ +
𝑛𝑛
𝑖𝑖)
=− 𝑛𝑛𝑖𝑖)𝑛𝑛𝑛𝑛 − 𝑠𝑠̅̅̅ = ( ) 𝑠𝑠̅̅̅ = (1 + 𝑖𝑖)𝑠𝑠̅̅̅ = 𝑠𝑠̅̅̅̅̅̅̅ − 1
𝑖𝑖) − −𝑠𝑠𝑑𝑑̅̅̅
𝑠𝑠̅̅̅ 𝑠𝑠𝑛𝑛|
̅̅̅
𝑛𝑛|
m-thly
𝑃𝑃𝑃𝑃 = 𝑎𝑎𝑛𝑛| 2
̅̅̅ = 𝑣𝑣 + 𝑣𝑣 + ⋯ + 𝑣𝑣 1 =
𝑛𝑛
−
1 11
−
𝑣𝑣 𝑛𝑛−𝑛𝑛𝑣𝑣𝑛𝑛𝑛𝑛
− 𝑣𝑣 𝑣𝑣 (𝐷𝐷𝐷𝐷) (𝐷𝐷𝐷𝐷)
(𝐷𝐷𝐷𝐷)
(𝐷𝐷𝐷𝐷) ̅̅̅ 𝑛𝑛| =𝑛𝑛|
̅̅̅
𝑛𝑛|
==
̅̅̅
̅̅̅ = 𝑛𝑛| 𝑖𝑖
𝑛𝑛|
(𝐷𝐷𝐷𝐷) (𝐷𝐷𝐷𝐷)
(𝐷𝐷𝐷𝐷)
(𝐷𝐷𝐷𝐷) ̅̅̅ 𝑛𝑛| =𝑛𝑛|
̅̅̅ ==
̅̅̅
̅̅̅ = 𝑖𝑖 𝑛𝑛| 𝑛𝑛| 𝑑𝑑 𝑛𝑛| 𝑛𝑛| 𝑛𝑛+1|
𝑛𝑛| 𝑛𝑛|
𝑃𝑃𝑃𝑃
𝑃𝑃𝑃𝑃
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
= =𝑎𝑎==𝑎𝑎 𝑎𝑎
= 𝑎𝑎 =𝑣𝑣 =
=+
𝑣𝑣 𝑣𝑣
+
𝑣𝑣 𝑣𝑣+ +
⋯2
2+2𝑣𝑣2 + ⋯𝑛𝑛+𝑛𝑛𝑣𝑣𝑛𝑛 =
+ 𝑣𝑣 +⋯+ ⋯ +
𝑣𝑣 +𝑣𝑣=𝑣𝑣 𝑛𝑛
= = 𝑖𝑖 𝑛𝑛|
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖 𝑛𝑛|
𝑖𝑖 𝑖𝑖 𝑖𝑖 𝑖𝑖 𝑛𝑛 (𝑚𝑚)
̅̅̅ 𝑛𝑛|
𝑛𝑛| ̅̅̅𝑛𝑛|̅̅̅
̅̅̅
𝑛𝑛|
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖 𝑛𝑛−1 (1 + 𝑖𝑖)𝑛𝑛𝑛𝑛 − 1
𝑛𝑛 Continuous 𝑛𝑛 −Annuity: 𝑎𝑎𝑛𝑛|
̅̅̅ 𝑛𝑛(1 + 𝑖𝑖) − 𝑠𝑠𝑛𝑛| ̅̅̅ 𝑎𝑎̅̅̅
𝑛𝑛|
=
𝐴𝐴𝐴𝐴 = 𝑠𝑠𝑛𝑛| ̅̅̅ = 1 + (1 + 𝑖𝑖) + ⋯ + (1 + 𝑖𝑖) (1= (1 +
𝑛𝑛 𝑛𝑛𝑖𝑖) − 1 = 𝑎𝑎𝑛𝑛| ̅̅̅ (1 + 𝑖𝑖)
𝑛𝑛 (𝐷𝐷𝑎𝑎̈ )𝑛𝑛| 𝑛𝑛 =
̅̅̅ 𝑛𝑛 𝑛𝑛−
− 𝑛𝑛
𝑎𝑎𝑛𝑛|−1− 𝑎𝑎𝑎𝑎𝑛𝑛|
𝑎𝑎𝑑𝑑𝑛𝑛|
− 𝑣𝑣 𝑛𝑛 (𝐷𝐷𝑠𝑠̈
𝑖𝑖 )𝑛𝑛| 𝑛𝑛(1
̅̅̅ =𝑛𝑛(1 𝑛𝑛(1
𝑛𝑛(1
+𝑛𝑛+ 𝑖𝑖)+ +
𝑛𝑛
𝑖𝑖)− 𝑛𝑛𝑖𝑖)𝑛𝑛𝑛𝑛 − 𝑠𝑠
𝑖𝑖) − −𝑠𝑠𝑛𝑛|
𝑠𝑠𝑛𝑛| 𝑠𝑠𝑛𝑛𝑛𝑛|
+(1
(1 𝑖𝑖)+
+ 𝑖𝑖)
𝑖𝑖)− 𝑖𝑖 1−1 1
− (𝐷𝐷𝑎𝑎̈ ) =
̅̅̅ ̅̅̅ ̅̅̅
̅̅̅
𝑛𝑛|
(𝐷𝐷𝑠𝑠̈ ) = 𝑑𝑑 ̅̅̅ ̅̅̅ ̅̅̅
̅̅̅
𝑛𝑛|
𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
= = ==
𝑠𝑠𝑛𝑛| 𝑠𝑠𝑠𝑠𝑛𝑛|
𝑠𝑠𝑛𝑛|
= =1=
̅̅̅
̅̅̅ =
+ 1+
(1
1 1+ + +(1
(1 (1
𝑖𝑖)+
+ + 𝑖𝑖)
+𝑖𝑖)
𝑖𝑖) ⋯+
+ +
⋯+⋯ ⋯(1+
+ +
(1 (1
+(1+𝑖𝑖)++
𝑛𝑛−1
𝑖𝑖)𝑖𝑖) 𝑛𝑛−1
𝑖𝑖)= ==
𝑛𝑛−1𝑛𝑛−1 = == 𝑎𝑎== 𝑎𝑎𝑎𝑎𝑛𝑛|
𝑎𝑎(1 (1+(1
̅̅̅
̅̅̅ (1 +
𝑛𝑛
𝑖𝑖)+
+ 𝑛𝑛𝑖𝑖)𝑛𝑛𝑛𝑛
𝑖𝑖)𝑖𝑖) (𝐷𝐷𝑎𝑎̈ (𝐷𝐷𝑎𝑎̈
(𝐷𝐷𝑎𝑎̈ )𝑛𝑛|
𝑃𝑃𝑃𝑃 ̅̅̅)𝑛𝑛| )
=𝑛𝑛|
̅̅̅ =
̅̅̅
̅̅̅
𝑛𝑛| =
̅̅̅ =
𝑎𝑎̅𝑛𝑛| (𝐷𝐷𝑠𝑠̈
=(𝐷𝐷𝑠𝑠̈(𝐷𝐷𝑠𝑠̈
()𝑛𝑛| ))𝑛𝑛|
̅̅̅ ̅̅̅)
𝑎𝑎=𝑛𝑛| = ∫ 𝑣𝑣 𝑑𝑑𝑑𝑑 = ∫ 𝑒𝑒 −𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑
̅̅̅
𝑛𝑛|
̅̅̅ = 𝑡𝑡
̅̅̅ ̅̅̅ 𝑛𝑛|
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖
̅̅̅
𝑛𝑛| ̅̅̅
𝑛𝑛| 𝑛𝑛|
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 𝛿𝛿 𝛿𝛿 𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 0 Contin
Annuity-Due: Increasing/Decreasing Perpetuity -𝑛𝑛Payments in Arithmetic
0 Progression:
Increasing/Decreasing
Increasing/Decreasing (1 + 𝑖𝑖)𝑛𝑛 −Perpetuity 1 Perpetuity 𝑖𝑖
Perpetuity -- Payments
Payments in Arithmetic
𝑛𝑛
Progression:
Annuity-Due:
Annuity-Due:
Annuity-Due:
Annuity-Due:
(PV at time of first payment, AV one period after last payment) Increasing/Decreasing
Increasing/Decreasing
𝐴𝐴𝐴𝐴 = 𝑠𝑠̅𝑛𝑛| ̅̅̅ = 1 1 𝛿𝛿 1 =Perpetuity
( ) 𝑠𝑠𝑛𝑛| - Payments
̅̅̅ = ∫ (1
- Payments
1 + 𝑖𝑖)𝑛𝑛−𝑡𝑡 inin in
Arithmetic
𝑑𝑑𝑑𝑑 =Arithmetic
Arithmetic
∫ 𝑒𝑒 𝛿𝛿(𝑛𝑛−𝑡𝑡) Progression:
Progression:
Progression:
𝑑𝑑𝑑𝑑 (𝐼𝐼𝑎𝑎̅ ̅)𝑛𝑛|
(PV(PV (PV
(PV
at at at
at
timetime time
time of of of
of
first first
first
first payment,
payment,
payment,
payment, 1AV
AV 𝑣𝑣one
one period
period after
after last
last payment)
payment) 𝛿𝛿 (𝐼𝐼𝑎𝑎̈ )̅̅̅̅ = ̅̅̅
𝑛𝑛−1AV AV one one periodperiod
− 𝑛𝑛
𝑖𝑖 afterafterlast last payment)
payment) (𝐼𝐼𝐼𝐼)∞| ̅̅̅̅1 =1 1 1 + 1 1 1 1 =1 11 ∞| 1 0 11
1 0
̅̅̅ = (1 + 𝑖𝑖)𝑎𝑎𝑛𝑛| 𝑖𝑖 + +=𝑖𝑖=
2
= 𝑖𝑖𝑖𝑖 = 𝑑𝑑
𝑃𝑃𝑃𝑃 = 𝑎𝑎̈ 𝑛𝑛| ̅̅̅ = 1 + 𝑣𝑣 + ⋯ + 𝑣𝑣 2
1= − 1 𝑣𝑣 1
− 1𝑛𝑛− −𝑑𝑑𝑛𝑛𝑣𝑣𝑣𝑣𝑛𝑛𝑛𝑛𝑖𝑖 =𝑖𝑖 (𝑖𝑖𝑑𝑑𝑖𝑖 ) 𝑎𝑎𝑛𝑛|
𝑣𝑣 ̅̅̅ = 1 + 𝑎𝑎𝑛𝑛−1| ̅̅̅̅̅̅̅
(𝐼𝐼𝐼𝐼) (𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼) ̅̅̅̅ ∞| ̅̅̅̅ =∞| ==
̅̅̅̅
̅̅̅̅
∞| =
++ 2 = 𝑖𝑖𝑖𝑖 (𝐼𝐼𝑎𝑎̈(𝐼𝐼𝑎𝑎̈ (𝐼𝐼𝑎𝑎̈
)(𝐼𝐼𝑎𝑎̈
̅̅̅̅)∞| )=
̅̅̅̅ )∞| ==
̅̅̅̅
̅̅̅̅
∞|
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
= 𝑃𝑃𝑃𝑃
𝑃𝑃𝑃𝑃=
𝑎𝑎̈ 𝑛𝑛|==
̅̅̅𝑎𝑎̈ 𝑛𝑛|
= 𝑎𝑎̈𝑎𝑎̈𝑛𝑛|
̅̅̅ ̅̅̅1=
=
̅̅̅
𝑛𝑛| +=
11 1+
𝑣𝑣+ 𝑣𝑣+𝑣𝑣 ⋯
+ 𝑣𝑣+ +⋯
⋯ ⋯+𝑛𝑛−1
𝑣𝑣 𝑣𝑣+𝑛𝑛−1
+ 𝑣𝑣𝑣𝑣= 𝑛𝑛−1
𝑛𝑛−1
=== == ( == () (𝑎𝑎()𝑛𝑛| ))𝑛𝑛|
̅̅̅𝑎𝑎
(1 =𝑎𝑎𝑎𝑎+
̅̅̅ =(1
̅̅̅
̅̅̅
𝑛𝑛|
𝑛𝑛| 𝑖𝑖)= =+(1
(1
𝑛𝑛
− (1
+1+
𝑖𝑖)𝑎𝑎 +𝑛𝑛|
𝑖𝑖)𝑎𝑎 𝑖𝑖)𝑎𝑎
̅̅̅𝑖𝑖)𝑎𝑎
=𝑖𝑖𝑛𝑛|
̅̅̅
𝑛𝑛| ̅̅̅1=
=
̅̅̅
𝑛𝑛| + =
1 𝑎𝑎1
+1𝑛𝑛−1|
++𝑛𝑛−1|
𝑎𝑎 𝑎𝑎𝑎𝑎𝑛𝑛−1|
̅̅̅̅̅̅̅ ̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
𝑛𝑛−1| Deferred
∞|
𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖𝑖𝑖Annuity:
2 𝑖𝑖 2𝑖𝑖𝑖𝑖2𝑖𝑖𝑖𝑖 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 ∞|
𝑑𝑑 2𝑑𝑑 2𝑑𝑑𝑑𝑑22
(1 (1 2 𝑑𝑑 𝑑𝑑 (1 𝑑𝑑
𝑑𝑑 𝑑𝑑 𝑛𝑛𝑑𝑑 𝑑𝑑𝑑𝑑 (1 m-thly Annuity: 𝑚𝑚 (𝐼𝐼𝑠𝑠̅ ̅)𝑛𝑛|
𝑚𝑚 |𝑎𝑎𝑛𝑛| 𝑚𝑚+1 |𝑎𝑎̈ 𝑛𝑛|
𝐴𝐴𝐴𝐴 = 𝑠𝑠̈ 𝑛𝑛| ̅̅̅ = + 𝑖𝑖) + + 𝑖𝑖) + ⋯ + + 𝑖𝑖) =(1 (1 +−𝑛𝑛𝑖𝑖)𝑖𝑖) 𝑛𝑛𝑛𝑛 − 1 = ( 𝑖𝑖 ) 𝑠𝑠𝑛𝑛| ̅̅̅ = + 𝑖𝑖)𝑠𝑠𝑛𝑛| ̅̅̅ = 𝑠𝑠𝑛𝑛+1| ̅̅̅̅̅̅̅ − 1 ̅̅̅ = ̅̅̅ = 𝑣𝑣 𝑎𝑎𝑛𝑛| ̅̅̅ = 𝑎𝑎𝑚𝑚+𝑛𝑛| ̅̅̅̅̅̅̅̅ − 𝑎𝑎𝑚𝑚| ̅̅̅̅ ̅̅̅
(1 (1
+ 𝑖𝑖) +𝑛𝑛+ 𝑖𝑖) 𝑑𝑑1− − 1 1 𝑖𝑖 𝑖𝑖 𝑖𝑖𝑑𝑑
𝐴𝐴𝐴𝐴
=𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 ̅̅̅=
𝑠𝑠̈=𝑛𝑛| 𝑠𝑠̈== 𝑠𝑠̈𝑠𝑠̈𝑛𝑛|
(1̅̅̅ =
= =
+(1
(1 (1
++
𝑖𝑖) +𝑖𝑖)
𝑖𝑖) (1
+𝑖𝑖)+ +(1
(1 (1
+2+
𝑖𝑖) ++2𝑖𝑖)𝑖𝑖)
𝑖𝑖) ⋯+22 + (1
+⋯⋯
+ ⋯+
+ +(1
(1 (1
+𝑛𝑛+
𝑖𝑖) 𝑖𝑖) 𝑛𝑛𝑛𝑛 =
+=𝑛𝑛𝑖𝑖)𝑖𝑖)= = = (= = ()=𝑠𝑠(()̅̅̅𝑠𝑠)=)̅̅̅𝑠𝑠𝑠𝑠̅̅̅
(1
̅̅̅ =
= =
+(1
(1 (1
++
𝑖𝑖)𝑠𝑠 + 𝑖𝑖)𝑠𝑠
̅̅̅𝑖𝑖)𝑠𝑠
𝑖𝑖)𝑠𝑠 = 𝑠𝑠= =𝑠𝑠=𝑛𝑛+1|
𝑠𝑠𝑠𝑠− 1− − 1−11 m-thly m-thly m-thly
m-thly Annuity: Annuity:
Annuity:
Annuity:
1 − 𝑣𝑣 𝑛𝑛 𝑎𝑎̈ ̅̅̅ 𝑛𝑛 (𝑚𝑚)
𝑎𝑎̈ 𝑛𝑛| − 𝑛𝑛𝑣𝑣 𝑛𝑛
𝑛𝑛| − 𝑛𝑛𝑣𝑣
̅̅̅ ̅̅̅𝑛𝑛| 𝑛𝑛| ̅̅̅
̅̅̅
̅̅̅ 𝑛𝑛| ̅̅̅̅̅̅̅
𝑛𝑛| ̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
𝑛𝑛+1|
𝑛𝑛|
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 𝑑𝑑 𝑑𝑑 𝑛𝑛| 𝑑𝑑𝑑𝑑 𝑛𝑛| 𝑛𝑛| 𝑛𝑛| 𝑛𝑛| 𝑛𝑛+1| 𝑛𝑛+1|
(𝑚𝑚) (𝑚𝑚) (𝑚𝑚) (𝑚𝑚) (𝑚𝑚) (𝑚𝑚)
̅̅̅
(𝑚𝑚) 𝑛𝑛 𝑛𝑛 𝑛𝑛𝑛𝑛
(𝑚𝑚)
Continuous Annuity: Perpetuity:
𝑎𝑎𝑛𝑛| ̅̅̅ 1 =−1 1−1
𝑣𝑣 𝑛𝑛−𝑛𝑛𝑣𝑣𝑛𝑛
− 𝑣𝑣 𝑣𝑣 𝑛𝑛 (𝐼𝐼𝐼𝐼) ̅̅̅
𝑛𝑛| 𝑎𝑎̈ =𝑎𝑎̈
̅̅̅ −
̅̅̅𝑎𝑎̈
𝑎𝑎̈ −
𝑛𝑛𝑣𝑣
̅̅̅
̅̅̅
𝑛𝑛| − −
𝑛𝑛𝑣𝑣𝑛𝑛 𝑛𝑛𝑣𝑣
𝑛𝑛𝑣𝑣 𝑛𝑛 𝑛𝑛 𝑛𝑛 (𝐼𝐼 𝑎𝑎) ̅̅̅
𝑛𝑛|
=
̅̅̅ 𝑎𝑎̈
𝑎𝑎̈
(𝑚𝑚) 𝑛𝑛| 𝑛𝑛|𝑛𝑛| 𝑖𝑖 𝑛𝑛𝑣𝑣
𝑎𝑎̈ 𝑎𝑎̈ ̅̅̅ − ̅̅̅
̅̅̅
𝑛𝑛|−𝑛𝑛𝑣𝑣−−𝑛𝑛𝑣𝑣
𝑛𝑛𝑣𝑣 Annui
Continuous
Continuous
Continuous
Continuous Annuity: Annuity:
1Annuity:
Annuity:− 𝑣𝑣 𝑛𝑛 𝑛𝑛 𝑛𝑛 (𝑚𝑚)(𝑚𝑚) (𝑚𝑚)
𝑎𝑎𝑎𝑎̅̅̅
(𝑚𝑚)
= 1(𝑚𝑚)(𝑚𝑚) 𝑖𝑖 (𝑚𝑚) (𝑚𝑚)(𝑚𝑚)
1(𝐼𝐼𝐼𝐼)
(𝑚𝑚) 𝑛𝑛| 𝑛𝑛|𝑛𝑛| 𝑖𝑖
(𝑚𝑚)
= (𝑚𝑚)(𝑚𝑚) 1(𝑚𝑚)
(𝑚𝑚)
(𝐼𝐼(𝑚𝑚) (𝐼𝐼𝑎𝑎)
(𝑚𝑚) (𝑚𝑚) (𝑚𝑚)
(𝑚𝑚)
𝑎𝑎) (𝑚𝑚)
(𝑚𝑚)
= (𝑚𝑚)(𝑚𝑚)
(𝑚𝑚)
𝑖𝑖 𝑎𝑎̅̅̅ 𝑎𝑎𝑛𝑛| = ̅̅̅== (𝑚𝑚) (𝐼𝐼𝐼𝐼) (𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼) = ̅̅̅== (𝐼𝐼(𝐼𝐼 𝑎𝑎) 𝑎𝑎) = ̅̅̅==
𝑃𝑃𝑃𝑃 = 𝑎𝑎̅𝑛𝑛| = 1− − 𝑛𝑛 = ( 𝑑𝑑 ) 𝑎𝑎 = ∫ 𝑛𝑛𝑣𝑣 𝑡𝑡𝑡𝑡 𝑑𝑑𝑑𝑑 = ∫𝑑𝑑 𝑛𝑛𝑒𝑒 −𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑 𝑑𝑑 𝑛𝑛|𝑑𝑑̅̅̅
𝑎𝑎 𝑛𝑛| 𝑛𝑛|
= 𝑖𝑖 𝑖𝑖 𝑖𝑖𝑖𝑖 (𝑚𝑚)
𝑎𝑎̈ =
̅̅̅ 𝑛𝑛|̅̅̅
𝑛𝑛| ̅̅̅ 𝑛𝑛|𝑛𝑛|
𝑎𝑎
̅ 𝑖𝑖 = 𝑖𝑖 𝑖𝑖𝑖𝑖 (𝑚𝑚) ̅̅̅ 𝑛𝑛|̅̅̅
𝑛𝑛| ̅̅̅ 𝑛𝑛|
𝑛𝑛| 𝑖𝑖 𝑖𝑖 𝑖𝑖
𝑖𝑖 (𝑚𝑚)
(𝑚𝑚)
1−
̅̅̅ 1 1− 𝑣𝑣 𝑛𝑛
𝑣𝑣 𝑣𝑣𝑣𝑣𝑡𝑡 𝑖𝑖 𝑖𝑖 𝑖𝑖𝛿𝛿𝑖𝑖 𝑃𝑃𝑛𝑛| ∑ 𝑡𝑡𝐴𝐴
𝑛𝑛 𝑛𝑛 ̅̅̅ 𝑛𝑛 𝑛𝑛 𝑛𝑛 𝑛𝑛 𝑛𝑛 𝑛𝑛
𝑃𝑃−𝛿𝛿𝛿𝛿 𝑃𝑃∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡+1 ∞|𝑃𝑃 𝑖𝑖
̅̅̅̅ ̅̅̅̅
∞| ̅̅̅̅̅
∞| 𝑃𝑃𝑃𝑃 = ∫
=∑ 𝑡𝑡𝐴𝐴𝛿𝛿𝑡𝑡=𝑣𝑣= 𝑣𝑣𝑡𝑡𝑡𝑡 𝑑𝑑𝑑𝑑 = 𝑑𝑑𝑑𝑑 −𝛿𝛿𝛿𝛿∑𝑑𝑑𝑑𝑑 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡+1 𝑑𝑑𝑑𝑑Continuously Increasing𝑑𝑑 Annuity: 𝛿𝛿
𝑃𝑃𝑃𝑃 = ̅𝑎𝑎̅𝑛𝑛| = ()𝑛𝑛| 𝑑𝑑𝑑𝑑
)𝑎𝑎)𝑛𝑛|𝑎𝑎𝑛𝑛| = ∫ − 𝑑𝑑𝑑𝑑= =
𝑡𝑡 0 𝑡𝑡𝑡𝑡𝑣𝑣 ∫
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃
= = 𝑎𝑎̅= 𝑎𝑎
=
𝑎𝑎̅(𝑖𝑖) = == (= ()(− 𝑎𝑎 (𝑖𝑖) 𝑎𝑎
= =∫= ∫𝑣𝑣∫ 𝑣𝑣𝑑𝑑𝑑𝑑
𝑣𝑣𝑑𝑑𝑑𝑑 = 𝑑𝑑𝑑𝑑=∫ =∫𝑒𝑒∫ −𝛿𝛿𝛿𝛿
𝑒𝑒𝑒𝑒𝑑𝑑𝑑𝑑
𝑒𝑒0 −𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑
𝛿𝛿𝑣𝑣 𝑡𝑡𝑖𝑖)𝐷𝐷𝑛𝑛𝛿𝛿=𝑚𝑚𝑚𝑚𝑚𝑚 = = 𝑛𝑛 − (𝑖𝑖) = 𝐷𝐷 = (𝑖𝑖) 𝑡𝑡 𝑣𝑣 = Continuously
−Continuously = 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 𝑣𝑣Increasing
̅̅̅
̅̅̅ ̅̅̅
̅̅̅
𝐷𝐷 𝑚𝑚𝑚𝑚𝑚𝑚
̅̅̅
𝑛𝑛| ̅̅̅
𝑛𝑛| 𝑛𝑛|
𝛿𝛿∑(1 𝛿𝛿𝐴𝐴𝛿𝛿+ −
̅̅̅
𝛿𝛿 𝛿𝛿1𝛿𝛿
̅̅̅ 𝑛𝑛|
𝑖𝑖 ∑ 𝑡𝑡 𝐷𝐷 𝑚𝑚𝑚𝑚𝑚𝑚 𝑛𝑛
𝑚𝑚𝑚𝑚𝑚𝑚
∑ 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 Continuously
Continuously Increasing
Increasing
Increasing Annuity: Annuity:
Annuity:
Annuity:
𝑡𝑡 𝑃𝑃 ( ) 𝑠𝑠 𝑡𝑡 =
0 0 𝐴𝐴
0 0 𝑣𝑣 0 0 0 0 𝑃𝑃 𝑛𝑛−𝑡𝑡 ∑ 𝐴𝐴= 𝑡𝑡
𝑡𝑡
𝑣𝑣𝑛𝑛∫𝑛𝑛𝑛𝑛𝑒𝑒 𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑃𝑃𝑑𝑑𝑑𝑑 𝐴𝐴 𝑡𝑡 𝑣𝑣 𝑃𝑃
Relationships: 𝑎𝑎
̅ ̅̅̅ − 𝑛𝑛𝑣𝑣
𝑛𝑛 𝑛𝑛 𝑛𝑛
𝐴𝐴𝐴𝐴 = 𝑠𝑠̅𝑛𝑛| (1(1
̅̅̅ = +(1 (1+𝑖𝑖)+ +
𝑛𝑛
𝑖𝑖)− 𝑖𝑖)
𝑛𝑛
𝑖𝑖) −𝑛𝑛
𝑛𝑛
11+𝑖𝑖− =
1 11 𝑖𝑖 𝑖𝑖 𝑖𝑖𝛿𝛿𝑖𝑖 𝑛𝑛|
− ̅̅̅ 𝑛𝑛 ∫
𝑛𝑛 𝑛𝑛𝑛𝑛 (1 + 𝑖𝑖) 𝑑𝑑𝑑𝑑 𝑛𝑛
(𝐼𝐼𝑎𝑎̅ ̅)̅̅̅ =
𝑛𝑛|
𝑛𝑛 𝑛𝑛𝑛𝑛 = ∫ 𝑛𝑛𝑛𝑛𝑡𝑡𝑣𝑣 𝑡𝑡 𝑑𝑑𝑑𝑑 = ∫𝑛𝑛𝑛𝑛𝑡𝑡𝑡𝑡 𝑎𝑎̈−𝛿𝛿𝛿𝛿 ̅̅̅̅̅𝑑𝑑𝑑𝑑
𝑎𝑎
̅ (𝐼𝐼𝐼𝐼)− 𝑛𝑛𝑛𝑛|𝑛𝑛𝑣𝑣 𝑛𝑛 𝑛𝑛
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐴𝐴𝐴𝐴
Perpetuity:
𝐴𝐴𝐴𝐴
== =
=𝑠𝑠̅𝑛𝑛|
𝑠𝑠̅𝑛𝑛| = 𝑠𝑠̅
𝑠𝑠̅𝑛𝑛| =
== 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 = = = 𝛿𝛿 Perpetuity: = (
(=()(𝑠𝑠)̅̅̅𝑠𝑠)𝑛𝑛| ) 𝐷𝐷
= 𝑠𝑠
𝑠𝑠̅̅̅ =∫=∫(1 = =
∫(1∫
1+𝑖𝑖 𝑛𝑛−𝑡𝑡
Mortgage
+(1 (1 + + 𝑖𝑖)
𝑛𝑛−𝑡𝑡
𝑖𝑖)+𝑖𝑖)𝑖𝑖)𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑛𝑛−𝑡𝑡
𝑛𝑛−𝑡𝑡
or 𝑑𝑑𝑑𝑑
=𝑑𝑑𝑑𝑑= Level
∫ = ∫ Mortgage
𝑒𝑒
𝛿𝛿(𝑛𝑛−𝑡𝑡)
=∫𝑒𝑒∫𝑒𝑒 Annuity: 𝛿𝛿(𝑛𝑛−𝑡𝑡)
𝛿𝛿(𝑛𝑛−𝑡𝑡)
𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑑𝑑𝑑𝑑
𝑒𝑒 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 = or Level
(𝐼𝐼𝐼𝐼)̅̅̅
Annuity:
𝑛𝑛|
𝐷𝐷 𝑎𝑎
̅
𝑛𝑛| 𝑎𝑎
̅̅̅̅ = −𝑎𝑎
̅
̅̅̅ −
̅̅̅𝑛𝑛𝑣𝑣
̅̅̅
𝑛𝑛|
𝑛𝑛| − 𝑛𝑛𝑣𝑣 𝑛𝑛𝑣𝑣
̅̅̅
𝛿𝛿𝑛𝑛 =̅̅̅= 𝑎𝑎 ̅̅̅̅̅
2𝑛𝑛|
𝑛𝑛 𝑛𝑛
2𝑛𝑛| 𝑎𝑎3𝑛𝑛|
̅̅̅̅̅ 𝐴𝐴𝐴𝐴 = ∫
̅̅̅ ̅̅̅ ̅̅̅
̅̅̅
𝑛𝑛|
𝛿𝛿 𝛿𝛿 𝛿𝛿𝛿𝛿 𝑖𝑖 𝛿𝛿 𝛿𝛿 𝛿𝛿𝑛𝑛| 𝛿𝛿 ̅̅̅𝑛𝑛|
̅̅̅
𝑚𝑚𝑚𝑚𝑚𝑚
𝑛𝑛| 0
𝑖𝑖
0
𝑎𝑎𝑛𝑛| ̅ ̅)𝑎𝑎
(𝐼𝐼𝑎𝑎
(𝐼𝐼 ̅ ̅)
𝑎𝑎(𝐼𝐼
(𝐼𝐼 ̅̅̅̅̅
̅̅̅
2𝑛𝑛|
𝑛𝑛| 𝑎𝑎̅ ̅)
𝑎𝑎̅ ̅) =
=𝑚𝑚𝑚𝑚𝑚𝑚
̅̅̅
𝑛𝑛| ==
̅̅̅
̅̅̅
𝑛𝑛|
𝑛𝑛|
𝑛𝑛|
𝑎𝑎=𝑛𝑛|
𝑛𝑛|
̅̅̅ + 𝑎𝑎𝑣𝑣𝑛𝑛| ̅̅̅ 𝑎𝑎 𝑛𝑛|∫= = ∫
∫𝑡𝑡𝑣𝑣∫𝑡𝑡𝑣𝑣 𝑡𝑡𝑣𝑣
0𝑡𝑡 𝑡𝑡𝑣𝑣
𝑑𝑑𝑑𝑑 𝑡𝑡
𝑡𝑡 𝑡𝑡=𝑑𝑑𝑑𝑑
=𝑑𝑑𝑑𝑑1
𝑑𝑑𝑑𝑑 =∫= =
+∫𝑡𝑡𝑡𝑡 𝑣𝑣∫𝑡𝑡𝑡𝑡
∫ 𝑛𝑛
0−𝛿𝛿𝛿𝛿 =𝑡𝑡𝑡𝑡
−𝛿𝛿𝛿𝛿
𝑡𝑡𝑡𝑡 𝑑𝑑𝑑𝑑 −𝛿𝛿𝛿𝛿
−𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 = 1 + 𝑣𝑣 𝑛𝑛 + 𝑣𝑣 2𝑛𝑛
Deferred Annuity:
0 0 00 𝑛𝑛 0 0 00 ̅̅̅
𝛿𝛿 𝛿𝛿 𝛿𝛿𝛿𝛿 𝑛𝑛 0𝑎𝑎
0 ̅̅̅
𝑛𝑛| 0 0 𝑎𝑎̈ ̅̅̅
𝑛𝑛|
𝑛𝑛 𝑎𝑎 ̅̅̅
𝑛𝑛|
𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼)𝑛𝑛| ̅̅̅ +𝑛𝑛𝑛𝑛𝑣𝑣
𝑛𝑛 𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼)𝑛𝑛| ̅̅̅ +𝑛𝑛𝑛𝑛𝑣𝑣 𝑠𝑠̅𝑛𝑛|
̅̅̅ − 𝑛𝑛
0 0 0 0
DeferredBond:
Deferred
Deferred
Deferred 𝑚𝑚 |𝑎𝑎𝑛𝑛|
𝐷𝐷
Annuity:
Annuity:
=
𝑚𝑚𝑚𝑚𝑚𝑚 =𝑚𝑚+1 |𝑎𝑎̈Bond:
Annuity:
Annuity: ̅̅̅ 𝑃𝑃= 𝑣𝑣 𝑎𝑎
𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚
𝑚𝑚 = ̅̅̅̅̅̅̅̅ Bond
̅̅̅ = 𝑎𝑎𝑚𝑚+𝑛𝑛| −𝑃𝑃 𝑎𝑎𝑚𝑚| ̅̅̅̅ Sold at Par: 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑎𝑎̈ ̅̅̅
Bond Sold𝑛𝑛|at Par: 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 = (𝐼𝐼 𝑎𝑎̈ 𝑛𝑛|𝑠𝑠̅ ̅)𝑛𝑛|
̅̅̅ =
𝑠𝑠̅𝑛𝑛|
̅̅̅ 𝑠𝑠̅̅̅̅
− 𝑠𝑠̅𝑠𝑠̅𝑛𝑛|
−𝑛𝑛− −𝑛𝑛 𝑛𝑛𝑛𝑛 = 𝑛𝑛 𝑛𝑛 ∫𝑛𝑛𝑛𝑛𝑡𝑡(1 + 𝑖𝑖)𝑛𝑛−𝑡𝑡 𝑑𝑑𝑑𝑑 = 𝑛𝑛 𝑛𝑛 ∫𝑛𝑛𝑛𝑛𝑡𝑡𝑡𝑡 𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑑𝑑𝑑𝑑 Geom
̅ ̅)Increasing =𝑛𝑛| 𝛿𝛿Annuity -𝑡𝑡(1
Payments 𝑛𝑛−𝑡𝑡 in Arithmetic 𝛿𝛿(𝑛𝑛−𝑡𝑡) Progression:
̅̅̅ 𝑛𝑛| 𝑛𝑛| ̅̅̅ ̅̅̅̅̅̅
𝑛𝑛|
|𝑎𝑎 = |𝑎𝑎̈ =
𝑚𝑚
𝑣𝑣𝑣𝑣𝑛𝑛|
𝑣𝑣𝑎𝑎𝑚𝑚 𝑎𝑎𝑚𝑚𝑛𝑛|
𝑚𝑚 𝑎𝑎𝑛𝑛| = 𝑎𝑎𝑎𝑎𝑚𝑚+𝑛𝑛| − 𝑎𝑎𝑎𝑎𝑚𝑚| (𝐼𝐼𝑠𝑠(𝐼𝐼 (𝐼𝐼
𝑠𝑠𝑛𝑛| ̅=
̅ ̅)𝑠𝑠̅ 𝑠𝑠𝑛𝑛|
(𝐼𝐼 ̅)̅)𝑛𝑛|== == ∫= =
∫ ∫∫𝑡𝑡(1
𝑛𝑛𝑡𝑡(1 0 𝑡𝑡(1
++ 𝑖𝑖)+ +
𝑛𝑛−𝑡𝑡
𝑖𝑖)𝑖𝑖)𝑖𝑖)𝑑𝑑𝑑𝑑
𝑛𝑛−𝑡𝑡 𝑛𝑛−𝑡𝑡 𝑑𝑑𝑑𝑑
=𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑 =∫= =∫𝑡𝑡𝑡𝑡 ∫ ∫𝑡𝑡𝑡𝑡0 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡
𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝛿𝛿(𝑛𝑛−𝑡𝑡)
𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 1st Pay
𝑚𝑚 |𝑎𝑎 |𝑎𝑎𝑚𝑚|𝑎𝑎 =𝑛𝑛|̅̅̅̅̅̅== |𝑎𝑎̈ |𝑎𝑎̈|𝑎𝑎̈
=𝑛𝑛| =𝑣𝑣=
̅̅̅
̅̅̅ 𝑎𝑎
= =𝑎𝑎=
̅̅̅
̅̅̅ 𝑎𝑎𝑚𝑚+𝑛𝑛| −−
̅̅̅̅̅̅̅̅
̅̅̅̅̅̅̅̅ −
𝑎𝑎𝑚𝑚| 𝑎𝑎𝑚𝑚| ̅̅̅̅
̅̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅
̅̅̅
𝑛𝑛|
̅̅̅̅̅̅̅ − (𝑛𝑛 + 1)
̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅̅̅̅̅̅
̅̅̅̅̅̅̅̅ ̅̅̅̅ ̅̅̅̅ 𝑎𝑎̈ − 𝑛𝑛𝑣𝑣 𝑠𝑠̈ ̅̅̅ − 𝑛𝑛 𝑠𝑠𝑛𝑛+1|
𝑛𝑛| 𝑚𝑚+1 𝑛𝑛| 𝑛𝑛| 𝑚𝑚+𝑛𝑛| 𝑚𝑚|
𝑚𝑚𝑚𝑚𝑛𝑛| 𝑛𝑛| 𝑚𝑚+1 𝑚𝑚+1𝑚𝑚+1 𝑛𝑛| 𝑛𝑛| 𝑚𝑚+𝑛𝑛| 𝛿𝛿 𝛿𝛿 ̅̅̅𝛿𝛿𝛿𝛿
Perpetuity:
Convexity: Convexity: (𝐼𝐼𝐼𝐼)
Annuity ̅̅̅ =
𝑛𝑛|
with
0
Varying
0 00
(𝐼𝐼𝐼𝐼)
Annual ̅̅̅ = Rate
𝑛𝑛| 0 0
of
0 0
=
Payment:
𝑛𝑛| 𝑛𝑛|
Perpetuity:
Perpetuity:
Perpetuity:
Perpetuity: 1 1 2 1 Annuity 𝑛𝑛 with 𝑖𝑖 Varying
Varying Annual 𝑖𝑖 of 𝑖𝑖
𝑑𝑑2 𝑠𝑠̈Rate 𝑛𝑛of Payment:
2 𝑛𝑛
1𝑑𝑑 𝑃𝑃𝑎𝑎̅∑
2 Annuity 𝑑𝑑Annuity
Annuity with with with VaryingVarying 𝑛𝑛 Annual Annual
Annual Rate RateRate of𝑡𝑡 of Payment: Payment:
Payment: 1
𝑎𝑎∞|
̅̅̅̅ 1= 1 11𝑖𝑖∑ 𝑡𝑡 2 𝐴𝐴𝑎𝑎̈ 𝑣𝑣 ̅̅̅̅
∞| 1𝑡𝑡 = 1 1𝑑𝑑 ̅̅̅̅̅
∞| 1𝑡𝑡 2= 1𝐴𝐴1𝑡𝑡1 𝛿𝛿𝑣𝑣 𝑡𝑡
2 𝑃𝑃∑ 𝑡𝑡(𝑡𝑡 + 1)𝐴𝐴 𝑣𝑣 𝑡𝑡+2 ∑ 𝑑𝑑 𝑡𝑡(𝑡𝑡 𝑃𝑃
+ 1)𝐴𝐴𝐶𝐶 𝑣𝑣 𝑡𝑡+2
+ 𝐷𝐷 𝑃𝑃𝑃𝑃 2 𝑃𝑃 =𝑛𝑛 𝑛𝑛 ∫ 𝑛𝑛𝑛𝑛𝑎𝑎̈𝑓𝑓(𝑡𝑡)𝑒𝑒
𝐶𝐶 ̅̅̅ − 𝑛𝑛𝑣𝑣
𝑛𝑛| + −𝛿𝛿𝛿𝛿
𝐷𝐷 𝑑𝑑𝑑𝑑 =
𝑛𝑛 𝑛𝑛 ∫ 𝑛𝑛𝑛𝑛 𝑓𝑓(𝑡𝑡)𝑒𝑒 − ∫0 𝛿𝛿−
̅̅̅
𝑛𝑛| 𝑟𝑟 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑 ̅̅̅̅̅̅̅ − (𝑛𝑛 + 1)
𝑠𝑠𝑛𝑛+1|
𝑃𝑃𝑃𝑃 =
𝑎𝑎∞| 𝑎𝑎∞| 𝑎𝑎∞|
𝑎𝑎
= ̅̅̅̅= = = 𝑎𝑎̈ ̅̅̅̅ 𝑎𝑎̈ =𝑎𝑎̈
𝑎𝑎̈𝑡𝑡̅̅̅̅=
̅̅̅̅ ==
∞|∞| =𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚∞| 𝑑𝑑𝛿𝛿𝑎𝑎
̅ 2
𝑎𝑎̅ 𝑎𝑎
̅𝑎𝑎
̅= =
̅̅̅̅̅ = = 𝑑𝑑𝛿𝛿 𝑡𝑡 𝑑𝑑𝑖𝑖 2 𝑡𝑡
𝑚𝑚𝑚𝑚𝑚𝑚 𝑑𝑑𝑖𝑖
𝑚𝑚𝑚𝑚𝑚𝑚(𝐼𝐼𝑎𝑎̈ ) ̅̅̅ = 𝑚𝑚𝑚𝑚𝑚𝑚 −𝛿𝛿𝛿𝛿𝑚𝑚𝑚𝑚𝑚𝑚 (𝐼𝐼𝑠𝑠̈ ) ̅̅̅ = 𝑡𝑡 𝑡𝑡 𝑡𝑡𝑡𝑡 =
𝑑𝑑 =∞|∞| = 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 == =𝑃𝑃𝑃𝑃 ∫=
̅̅̅̅ ̅̅̅̅̅̅̅̅ ̅̅̅̅ ̅̅̅̅̅ ̅̅̅̅̅
̅̅̅̅̅ 𝑛𝑛| 𝑛𝑛| − − ∫ 𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑
𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 𝑖𝑖 𝑖𝑖=𝑖𝑖𝑖𝑖 ∑∞| 𝑃𝑃𝑃𝑃 = ∫𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑓𝑓(𝑡𝑡)𝑒𝑒 −𝛿𝛿𝛿𝛿 𝑑𝑑𝑑𝑑 = ∫0𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑓𝑓(𝑡𝑡)𝑒𝑒
− − 𝛿𝛿 𝑑𝑑𝑑𝑑
∫𝛿𝛿 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑
∑𝛿𝛿 𝐴𝐴𝛿𝛿𝑡𝑡𝛿𝛿𝑣𝑣𝛿𝛿𝑡𝑡 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 𝑃𝑃= =
∞| ∞| ∞| −𝛿𝛿𝛿𝛿 −𝛿𝛿𝛿𝛿 ∫ ∫
𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃
= = ∫= ∫ 0 𝑓𝑓(𝑡𝑡)𝑒𝑒
𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 =𝑑𝑑𝑑𝑑=∫= ∫
∫𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑟𝑟 00
𝑑𝑑𝑟𝑟 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
𝑟𝑟 𝑑𝑑𝑑𝑑 𝑟𝑟
𝑑𝑑
𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡𝑑𝑑 𝑑𝑑 𝑑𝑑 𝑃𝑃
0 0
Relationships: ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 𝑃𝑃 ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 (1 + 𝑖𝑖)2 𝑃𝑃 0 0 00𝑛𝑛 (1 + 𝑖𝑖)2 0 0 00 𝑛𝑛
Relationships:
Relationships:
Relationships:
Relationships: 𝑎𝑎2𝑛𝑛|̅̅̅̅̅ 𝑎𝑎̈ 2𝑛𝑛|
̅̅̅̅̅ 𝑎𝑎3𝑛𝑛| ̅̅̅̅̅
𝐴𝐴𝐴𝐴 = ∫𝑛𝑛𝑛𝑛𝑓𝑓(𝑡𝑡)𝑒𝑒 𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑑𝑑𝑑𝑑 = ∫𝑛𝑛𝑛𝑛𝑓𝑓(𝑡𝑡)𝑒𝑒
𝑛𝑛
∫𝑡𝑡 𝛿𝛿𝑟𝑟 𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑
2𝑛𝑛| = 𝑎𝑎𝑛𝑛|
𝑎𝑎̅̅̅̅̅ ̅̅̅ + 𝑣𝑣 𝑎𝑎̅̅̅
𝑛𝑛
𝑛𝑛| 𝑎𝑎̅̅̅̅̅ ̅̅̅̅̅ = 1 + 𝑣𝑣 𝑎𝑎̈ 2𝑛𝑛|
𝑎𝑎𝑎𝑎𝑎𝑎2𝑛𝑛|
𝑎𝑎̅̅̅̅̅ ̅̅̅̅̅
𝑛𝑛
=
̅̅̅̅̅ 𝑎𝑎̈𝑎𝑎̈𝑎𝑎̈2𝑛𝑛|
𝑎𝑎̈ ̅̅̅̅̅ ̅̅̅̅̅ 𝑎𝑎3𝑛𝑛|
̅̅̅̅̅ 𝑎𝑎3𝑛𝑛|
̅̅̅̅̅ ̅̅̅̅̅ ̅̅̅̅̅ = 1 + 𝑣𝑣 + 𝑣𝑣
𝑎𝑎𝑎𝑎𝑎𝑎3𝑛𝑛|
̅̅̅̅̅
𝑛𝑛 2𝑛𝑛
Loans
𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴 =
𝑛𝑛 𝑛𝑛
∫𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑓𝑓(𝑡𝑡)𝑒𝑒
𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝛿𝛿(𝑛𝑛−𝑡𝑡)
𝛿𝛿(𝑛𝑛−𝑡𝑡)
𝛿𝛿(𝑛𝑛−𝑡𝑡) 𝑑𝑑𝑑𝑑 =
𝑛𝑛 𝑛𝑛
∫𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑓𝑓(𝑡𝑡)𝑒𝑒
𝑛𝑛 𝑛𝑛 𝑛𝑛𝑛𝑛
∫𝑡𝑡 ∫ ∫𝑡𝑡𝑡𝑡𝑟𝑟𝛿𝛿
𝛿𝛿𝑡𝑡𝑟𝑟∫𝑑𝑑𝑑𝑑
𝛿𝛿 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑
𝛿𝛿𝑟𝑟𝑟𝑟𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑
𝑎𝑎̅̅̅̅̅
𝑎𝑎 𝑎𝑎
𝑎𝑎= ̅̅̅̅̅ =𝑎𝑎 = =
𝑎𝑎 + 𝑎𝑎
𝑎𝑎 +𝑣𝑣
̅̅̅ +𝑛𝑛+𝑛𝑛𝑣𝑣𝑛𝑛𝑛𝑛 𝑎𝑎̅̅̅ 2𝑛𝑛|2𝑛𝑛|
𝑣𝑣𝑎𝑎𝑣𝑣 𝑎𝑎 𝑎𝑎 =
2𝑛𝑛|
̅̅̅ =
=
𝑛𝑛|1 =+
1 1
+1
𝑣𝑣 𝑛𝑛+𝑛𝑛𝑣𝑣𝑛𝑛𝑛𝑛 =2𝑛𝑛|
+ 𝑣𝑣 𝑣𝑣
= = =
2𝑛𝑛|
̅̅̅
𝑛𝑛| =
3𝑛𝑛|
̅̅̅ =
𝑛𝑛|=1 =
+
1 1+ 1
𝑣𝑣 +𝑛𝑛+𝑛𝑛𝑣𝑣𝑛𝑛𝑛𝑛 2𝑛𝑛
𝑣𝑣+ 𝑣𝑣 +
𝑣𝑣 + +
𝑣𝑣 𝑣𝑣
2𝑛𝑛
𝑣𝑣 2𝑛𝑛2𝑛𝑛 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = = ∫= ∫
∫𝑓𝑓(𝑡𝑡)𝑒𝑒0 𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑=𝑑𝑑𝑑𝑑=∫= ∫
∫𝑓𝑓(𝑡𝑡)𝑒𝑒0 𝑓𝑓(𝑡𝑡)𝑒𝑒 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
𝑡𝑡𝑎𝑎and 𝑃𝑃 are duration and price of components of Portfolio0 0 00
𝑛𝑛| Duration
̅̅̅𝐷𝐷𝑡𝑡 of a Portfolio:
̅̅̅̅̅
̅̅̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅ 𝐷𝐷̅̅̅
2𝑛𝑛|2𝑛𝑛| 2𝑛𝑛|
Duration
2𝑛𝑛| 𝑛𝑛| 𝑛𝑛|𝑛𝑛| of 𝑛𝑛| 𝑛𝑛|
a 𝑛𝑛| 𝑛𝑛|
Portfolio: 𝑎𝑎𝑛𝑛| 𝑎𝑎𝑛𝑛|𝑎𝑎𝑎𝑎𝑛𝑛| and 𝑃𝑃𝑡𝑡 𝑎𝑎̈are 𝑎𝑎̈𝑎𝑎̈duration
𝑎𝑎̈ 𝑛𝑛| ̅̅̅ 𝑎𝑎 𝑎𝑎𝑎𝑎𝑛𝑛| and
𝑛𝑛| 𝑡𝑡price of components of Portfolio
̅̅̅ 0 0 00
Increasing Annuity
̅̅̅ ̅̅̅
- Payments
̅̅̅
𝑛𝑛|
in𝐷𝐷𝐷𝐷
̅̅̅
𝑛𝑛| ̅̅̅ ̅̅̅
𝑛𝑛|
𝑛𝑛|
𝑃𝑃𝑛𝑛1𝑃𝑃𝑛𝑛+ 𝐷𝐷2 𝑃𝑃2 +Progression:
𝑛𝑛| ̅̅̅
𝑛𝑛| ̅̅̅
⋯ + 𝐷𝐷𝑛𝑛 𝑃𝑃𝑛𝑛 Geometric
Amortization Annuity-Immediate:
Method:
𝐷𝐷1 𝑃𝑃1 + 𝐷𝐷2 𝑃𝑃2 + ⋯ + 1Arithmetic
Geometric Geometric
1stst Payment
Geometric
Geometric Annuity-Immediate:
Annuity-Immediate:
Annuity-Immediate:
Annuity-Immediate:
is 1,
𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
Increasing
Increasing
Increasing
Increasing Annuity
𝑎𝑎̈ 𝑛𝑛|̅̅̅ −=𝑛𝑛𝑣𝑣 𝑛𝑛-𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
Annuity
Annuity
Annuity Payments-- Payments
-𝑃𝑃Payments+
Payments
𝑃𝑃 + inin
⋯
=
+ inin
𝑠𝑠̈Arithmetic
̅̅̅ Arithmetic
Arithmetic
Arithmetic
𝑃𝑃 − 𝑛𝑛𝑃𝑃1 + 𝑃𝑃 Progression:
𝑠𝑠𝑛𝑛+1| +
̅̅̅̅̅̅̅ Progression:
Progression:
Progression:
⋯ − (𝑛𝑛𝑃𝑃+ 1)
+ Levelst payment 𝑅𝑅, Subsequent
Outstanding Payments balance 𝐵𝐵𝑡𝑡Increasing , Principal by repayment𝑘𝑘% 𝑃𝑃𝑡𝑡
(𝐼𝐼𝐼𝐼)𝑛𝑛| ̅̅̅𝑎𝑎̈ 𝑛𝑛| = 𝑎𝑎̈𝑎𝑎̈𝑛𝑛|
𝑎𝑎̈ 𝑛𝑛|
− ̅̅̅ −𝑛𝑛𝑣𝑣
̅̅̅ −− 𝑛𝑛 𝑛𝑛𝑣𝑣
𝑛𝑛𝑣𝑣 𝑛𝑛𝑣𝑣𝑛𝑛 𝑛𝑛𝑛𝑛 1 (𝐼𝐼𝐼𝐼) 2 ̅̅̅ = 𝑠𝑠̈ 𝑛𝑛
𝑠𝑠̈ 𝑛𝑛|
𝑛𝑛|
𝑛𝑛|
𝑠𝑠̈ 𝑛𝑛|
̅̅̅𝑠𝑠̈ 𝑛𝑛|
− −𝑛𝑛−
̅̅̅
̅̅̅ −
𝑛𝑛 𝑛𝑛𝑛𝑛𝑠𝑠𝑛𝑛+1| =𝑠𝑠𝑛𝑛+1| 2
𝑠𝑠𝑠𝑠𝑛𝑛+1|
−−
̅̅̅̅̅̅̅
̅̅̅̅̅̅̅ (𝑛𝑛− −(𝑛𝑛+(𝑛𝑛(𝑛𝑛
+1)+ + 𝑛𝑛
1)1) 1)
st st
11Payment
1 1Payment Payment
Payment is is 1,isis 1, 1,1,
Subsequent Subsequent
Subsequent
Subsequent
𝑛𝑛 Payments Payments
Payments
Payments Increasing Increasing
Increasing
Increasing byby by
by
𝑘𝑘% 𝑘𝑘% 𝑘𝑘%
𝑘𝑘%
(𝐼𝐼𝐼𝐼) (𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼)
̅̅̅
=
̅̅̅ 𝑛𝑛| 𝑖𝑖 (𝐼𝐼𝐼𝐼)
(𝐼𝐼𝐼𝐼) =
̅̅̅ 𝑛𝑛| 𝑖𝑖 ̅̅̅̅̅̅̅
=
̅̅̅̅̅̅̅ 𝑛𝑛+1| 𝑖𝑖 𝐿𝐿 = 𝑅𝑅𝑎𝑎1𝑛𝑛| 1 + 𝑘𝑘 𝑅𝑅 = 𝑃𝑃𝑡𝑡 + 𝐼𝐼𝑡𝑡 𝐼𝐼𝑡𝑡 = 𝑅𝑅 − 𝑃𝑃𝑡𝑡 = 𝑅𝑅(1𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 − 𝑣𝑣 𝑛𝑛−𝑡𝑡+1 )
=𝑛𝑛|̅̅̅̅̅̅== 𝑛𝑛 (𝐼𝐼𝐼𝐼) (𝐼𝐼𝐼𝐼) =𝑛𝑛| ==
̅̅̅
̅̅̅ = == ̅̅̅− ( 𝑛𝑛 𝑛𝑛)𝑛𝑛𝑛𝑛 𝑜𝑜𝑜𝑜 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇
) 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆 = (1𝑠𝑠𝑠𝑠 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇) (1 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
̅̅̅
𝑛𝑛| ̅̅̅ 𝑛𝑛| ̅̅̅
𝑛𝑛| ̅̅̅ 𝑛𝑛|
𝑛𝑛|
First-Order 𝑎𝑎̈𝑖𝑖 𝑛𝑛| −𝑖𝑖𝑖𝑖 𝑛𝑛𝑣𝑣 𝑛𝑛First-Order
̅̅̅𝑖𝑖 Modified Price
𝑛𝑛|
𝑖𝑖𝑠𝑠̈ 𝑛𝑛|
Modified
Approximation: 𝑖𝑖 𝑖𝑖−
̅̅̅ 𝑖𝑖 𝑛𝑛 Price 𝑠𝑠𝑛𝑛+1|
̅̅̅̅̅̅̅ −
𝑖𝑖𝑃𝑃(𝑖𝑖)𝑖𝑖 𝑖𝑖(𝑛𝑛𝑖𝑖 ≈+𝑃𝑃(𝑖𝑖
Approximation: 1) ) − 𝑃𝑃(𝑖𝑖𝑃𝑃(𝑖𝑖) )(𝑖𝑖 −≈𝑖𝑖𝑃𝑃(𝑖𝑖 )𝐷𝐷 0 ) −(𝑖𝑖𝑃𝑃(𝑖𝑖 )
𝑃𝑃𝑃𝑃 0 )(𝑖𝑖
= 1 −1−
1 − 𝑖𝑖+01()𝐷𝐷
(
1+11+
𝑘𝑘 +𝑘𝑘
+
𝑚𝑚𝑚𝑚𝑚𝑚 𝑘𝑘𝑘𝑘𝑖𝑖 (𝑖𝑖
) ) 0 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 )
(𝐼𝐼𝑎𝑎̈ )𝑛𝑛| ̅̅̅𝑎𝑎̈ 𝑛𝑛| = 𝑎𝑎̈𝑎𝑎̈𝑛𝑛|
𝑎𝑎̈ 𝑛𝑛|
− −
𝑛𝑛𝑣𝑣− − 𝑛𝑛
𝑛𝑛𝑣𝑣 𝑛𝑛𝑣𝑣
𝑛𝑛𝑣𝑣𝑛𝑛 𝑛𝑛 (𝐼𝐼𝑠𝑠̈ )𝑛𝑛| 𝑠𝑠̈
̅̅̅ =𝑠𝑠̈ − 𝑠𝑠̈
𝑠𝑠̈ −𝑛𝑛 − −𝑛𝑛 𝑛𝑛 𝑛𝑛𝑠𝑠 = 𝑠𝑠 𝑠𝑠 𝑠𝑠 − (𝑛𝑛
− − −(𝑛𝑛 + (𝑛𝑛
(𝑛𝑛 +
1) + +
1) 1)1) 0 0 0 𝑚𝑚𝑚𝑚𝑚𝑚 0 1 −1 −( ( 1 1 )+ + )𝑖𝑖𝑖𝑖 𝑛𝑛−𝑡𝑡+1 𝑠𝑠 1 −1 11
− − −
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁
𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁
𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁
𝑜𝑜𝑜𝑜 𝑜𝑜𝑜𝑜 𝑜𝑜𝑜𝑜
𝑜𝑜𝑜𝑜 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇
̅̅̅ ̅̅̅ ̅̅̅ ̅̅̅
𝑛𝑛| 𝑑𝑑 ̅̅̅ ̅̅̅
𝑛𝑛| 𝑛𝑛|𝑛𝑛| 𝑑𝑑 ̅̅̅
̅̅̅
𝑛𝑛| ̅̅̅̅̅̅̅
𝑛𝑛+1| ̅̅̅̅̅̅̅ ̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
𝑛𝑛+1|
𝑛𝑛+1| 𝑑𝑑 𝑃𝑃𝑃𝑃𝑃𝑃 == 1
=𝑅𝑅 − 𝐼𝐼𝑡𝑡𝑖𝑖 − +
1 +𝑖𝑖
= 𝑘𝑘 𝑖𝑖
𝑅𝑅𝑣𝑣 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑃𝑃𝑡𝑡+𝑠𝑠𝑆𝑆𝑆𝑆𝑆𝑆
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 =𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃𝑆𝑆𝑆𝑆𝑆𝑆(1 + = 𝑖𝑖)(1𝑠𝑠𝑠𝑠 𝐼𝐼𝑡𝑡 = ( 𝑖𝑖𝐵𝐵
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇) 1 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 ) ) ))
(𝐼𝐼𝑎𝑎̈
)(𝐼𝐼𝑎𝑎̈
(𝐼𝐼𝑎𝑎̈(𝐼𝐼𝑎𝑎̈
̅̅̅)𝑛𝑛| =
̅̅̅))𝑛𝑛|
̅̅̅̅̅̅== = (𝐼𝐼𝑠𝑠̈
)(𝐼𝐼𝑠𝑠̈
(𝐼𝐼𝑠𝑠̈(𝐼𝐼𝑠𝑠̈ ̅̅̅)𝑛𝑛|=))𝑛𝑛|
̅̅̅ ==
̅̅̅
̅̅̅ = = == = 𝑛𝑛+1| 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃
= 𝑡𝑡= 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑡𝑡= = (1𝑠𝑠𝑠𝑠
= (1𝑠𝑠𝑠𝑠 (1𝑠𝑠𝑠𝑠
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇) 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇)
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇) ( (( 𝑡𝑡−1
𝑛𝑛| 𝑛𝑛|
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 𝑛𝑛| 𝑛𝑛|
𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 𝑑𝑑 𝑑𝑑 𝑑𝑑𝑑𝑑 1+𝑖𝑖0 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚(𝑖𝑖0 ) 1+𝑖𝑖0 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 𝑖𝑖 (𝑖𝑖−𝑖𝑖0)− 𝑖𝑖𝑘𝑘𝑖𝑖− −𝑘𝑘 𝑘𝑘𝑘𝑘 1− 1 1− 1− − 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
First-Order Macaulay Price Approximation: 𝑃𝑃(𝑖𝑖) ≈ 𝑃𝑃(𝑖𝑖0 ) ( First-Order Macaulay Price Approximation: ) 𝑃𝑃(𝑖𝑖) ≈ 𝑃𝑃(𝑖𝑖 ) ( )
∑ 𝐼𝐼𝑡𝑡 = 𝑛𝑛𝑛𝑛 − 𝐿𝐿 ∑ 𝑃𝑃𝑡𝑡 = 𝐿𝐿 𝐵𝐵𝑡𝑡 = 𝐵𝐵𝑡𝑡−1 − 𝑃𝑃𝑡𝑡
Loans 1+𝑖𝑖
0 1+𝑖𝑖
Loans
Loans
Loans
Loans Interest Rate Swaps
LOANS 𝑛𝑛−𝑡𝑡| (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
𝐵𝐵𝑡𝑡 = 𝑅𝑅𝑎𝑎̅̅̅̅̅̅̅ Interest Interest
Interest
Interest 𝐵𝐵Rate
𝑡𝑡 = Rate
𝐿𝐿(1Swaps
Rate
Rate +Swaps𝑖𝑖) 𝑡𝑡
Swaps
Swaps − 𝑅𝑅𝑠𝑠𝑡𝑡|̅ (𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅)
Amortization Method:
Amortization
Amortization
Amortization
Amortization
Level payment Method: Method:
Method:
Method: 𝑅𝑅, Outstanding balance 𝐵𝐵𝑡𝑡 , Principal repayment 𝑃𝑃𝑡𝑡 IMMUNIZATION IMMUNIZATION
Sinking Fund Method: Constant Notional Value:
LevelLevel Level
Level payment payment
payment
payment 𝑅𝑅,𝑅𝑅, 𝑅𝑅,
𝑅𝑅, Outstanding
Outstanding
Outstanding
Outstanding balance balance
balance
balance 𝐵𝐵𝑡𝑡𝐵𝐵 𝐵𝐵
, 𝑡𝑡𝐵𝐵
Principal,, Principal
,𝑡𝑡𝑡𝑡Principal Principal repayment repayment
repayment
repayment 𝑃𝑃𝑡𝑡 𝑃𝑃𝑡𝑡𝑃𝑃𝑃𝑃𝑡𝑡𝑡𝑡 𝑛𝑛−𝑡𝑡+1 Loan 𝐿𝐿, SF Deposit D, Constant Constant
Constant
Constant
n year Notional
Interest on
swap Notional
Notional
Notional
Loan rate 𝑖𝑖,Value:
𝑅𝑅Value:
= Value:
Value:
Interest 1−𝑃𝑃𝑛𝑛
on SF 𝑗𝑗
𝐿𝐿 = 𝑅𝑅𝑎𝑎𝑛𝑛| 𝑅𝑅 =(i)𝑃𝑃 + 𝐼𝐼𝑡𝑡 = 𝐼𝐼PV(Liabilities)
= PV(Assets)
𝑡𝑡 (i) 𝑅𝑅 − 𝑃𝑃𝑡𝑡 = 𝑅𝑅(1=−PV(Liabilities) 𝑣𝑣 ) (i) 𝑡𝑡∑𝑛𝑛𝑃𝑃𝑛𝑛𝑖𝑖𝑛𝑛∑ 𝐴𝐴 𝑣𝑣 𝑡𝑡 = 𝐿𝐿 ∑ 𝐿𝐿𝑡𝑡 𝑣𝑣 𝑡𝑡𝑃𝑃 −𝑃𝑃
Redington Immunization: 𝑡𝑡 ∑(i)
1−𝑃𝑃
Redington ̅̅̅ Immunization: 𝑡𝑡PV(Assets)
𝑛𝑛−𝑡𝑡+1 ) (i) 𝑃𝑃𝐴𝐴 = 𝑃𝑃𝐿𝐿 n 𝑃𝑃
year
n 𝐴𝐴nn= 𝑃𝑃
year
year
year swap(i)
𝐿𝐿swap ∑
swap𝐴𝐴
swap
rate 𝑣𝑣 𝑡𝑡 = ∑1−𝑃𝑃
rate
rate
𝑡𝑡rate 𝑅𝑅 𝑅𝑅
= 𝑅𝑅
𝑅𝑅= 𝐿𝐿
= =1−𝑃𝑃𝑛𝑛1−𝑃𝑃
𝑣𝑣 𝑡𝑡 1 1
𝐿𝐿 = 𝐿𝐿 𝐿𝐿=𝐿𝐿𝑅𝑅𝑎𝑎
== 𝑅𝑅𝑎𝑎 𝑅𝑅𝑎𝑎
𝑅𝑅𝑎𝑎 ̅̅̅ 𝑅𝑅 𝑅𝑅
= 𝑅𝑅𝑅𝑅
= 𝑃𝑃 = =𝑃𝑃+ 𝑃𝑃 𝑃𝑃+
𝐼𝐼 + +
𝐼𝐼 𝐼𝐼𝑡𝑡𝑡𝑡
𝐼𝐼 𝐼𝐼 𝐼𝐼
= 𝐼𝐼𝐼𝐼=𝑅𝑅 = =𝑅𝑅
−
(ii) 𝑅𝑅
𝑅𝑅
−𝑃𝑃 −−𝑃𝑃= 𝑃𝑃𝑃𝑃𝑡𝑡=
Duration(Assets) =
𝑅𝑅(1=𝑅𝑅(1 𝑅𝑅(1
𝑅𝑅(1
− −
𝑣𝑣 −−
𝑛𝑛−𝑡𝑡+1
𝑣𝑣 𝑣𝑣 𝑣𝑣 )= )Duration(Liabilities)
𝑛𝑛−𝑡𝑡+1
𝑛𝑛−𝑡𝑡+1 ) 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 𝐼𝐼 +(ii)𝐷𝐷 𝑃𝑃′ 𝐼𝐼 =
t-year
= 𝑖𝑖𝑖𝑖
𝑃𝑃′ deferred 𝐿𝐿 =
𝑡𝑡 m 𝐷𝐷𝑠𝑠 year
∑𝑛𝑛| ∑ 𝑃𝑃𝑖𝑖𝑖𝑖𝑡𝑡 ∑𝐷𝐷 rate:
𝑖𝑖swap
̅̅̅𝑃𝑃𝑗𝑗∑𝑖𝑖 𝑃𝑃(ii) 𝑃𝑃
𝑡𝑡𝐴𝐴 = 𝑣𝑣 𝑡𝑡 = 𝑅𝑅 = ∑ 𝑡𝑡𝐿𝐿
𝑡𝑡 𝑡𝑡 𝑡𝑡+𝑚𝑚
𝑣𝑣 = 𝑖𝑖 +
𝑃𝑃𝑡𝑡+𝑠𝑠(ii) = Duration(Assets) = Duration(Liabilities) (ii) 𝑃𝑃′𝐴𝐴 = 𝑃𝑃′𝐿𝐿 (ii)𝐿𝐿 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 = 𝑡𝑡𝐿𝐿𝑡𝑡 𝑣𝑣
̅̅̅ ̅̅̅
̅̅̅𝑛𝑛|
𝑛𝑛| 𝑛𝑛| 𝑛𝑛|
𝑃𝑃𝑡𝑡 = 𝑅𝑅 − 𝐼𝐼𝑡𝑡 = 𝑅𝑅𝑣𝑣 𝑛𝑛−𝑡𝑡+1
𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡
𝑡𝑡 𝑡𝑡
𝑃𝑃𝑡𝑡 (1 + 𝑖𝑖)𝑠𝑠 𝐼𝐼𝑡𝑡 = 𝑖𝑖𝐵𝐵
𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡 𝑡𝑡
𝐴𝐴 ∑ ∑ 𝑡𝑡 𝑠𝑠𝑛𝑛| ̅̅̅ 𝑃𝑃𝑡𝑡 −𝑃𝑃
𝑃𝑃𝑡𝑡+1 𝑃𝑃𝑡𝑡𝑡𝑡𝑡𝑡𝑎𝑎
𝑃𝑃
−𝑃𝑃 −𝑃𝑃
−𝑃𝑃
+⋯+𝑃𝑃
̅̅̅ 𝑠𝑠 ̅̅̅𝑖𝑖
t-year
t-year deferred
deferred m year swap rate: 𝑡𝑡+𝑚𝑚
𝑣𝑣m year 𝑡𝑡swap 𝑡𝑡 rate: =𝑅𝑅𝑅𝑅 = ∑ 𝑡𝑡 2 𝐿𝐿 𝑣𝑣 𝑡𝑡
𝑗𝑗 𝑛𝑛| 𝑖𝑖 𝑛𝑛|
(iii) 𝑡𝑡−1
Convexity(Assets) > Convexity(Liabilities) t-year
(iii) t-year deferred
deferred 𝑡𝑡 2m𝐴𝐴 myear 𝑡𝑡year swap
∑swap 𝐿𝐿rate:
(iii) ∑rate: 2𝑅𝑅 𝑅𝑅 𝑡𝑡== 𝑡𝑡 𝑡𝑡+𝑚𝑚 𝑡𝑡+𝑚𝑚
𝑡𝑡+𝑚𝑚 𝑡𝑡+𝑚𝑚
𝐴𝐴 >(iii)
at𝑃𝑃"time 𝑃𝑃" 𝑡𝑡 𝑣𝑣 𝑡𝑡 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑃𝑃𝑡𝑡+1 >
2
𝑡𝑡𝑃𝑃
𝑃𝑃𝑡𝑡 𝑃𝑃= 𝑃𝑃𝑡𝑡=
𝑡𝑡 =
𝑅𝑅 =−𝑅𝑅𝑅𝑅
𝑅𝑅 𝐼𝐼𝑡𝑡−
− − 𝑡𝑡 𝐼𝐼𝐼𝐼=
𝐼𝐼= =
𝑡𝑡 =
𝑡𝑡𝑅𝑅𝑣𝑣𝑅𝑅𝑣𝑣𝑅𝑅𝑣𝑣
𝑛𝑛−𝑡𝑡+1
𝑅𝑅𝑣𝑣 𝑛𝑛−𝑡𝑡+1
𝑛𝑛−𝑡𝑡+1
𝑛𝑛−𝑡𝑡+1
𝑃𝑃𝑡𝑡+𝑠𝑠 𝑃𝑃𝑃𝑃=
𝑃𝑃𝑡𝑡+𝑠𝑠 =
𝑡𝑡+𝑠𝑠
𝑡𝑡+𝑠𝑠 𝑃𝑃(iii)
𝑡𝑡==(1𝑡𝑡𝑃𝑃𝑃𝑃
𝑃𝑃 (1Convexity(Assets)
𝑡𝑡+ (1
𝑡𝑡(1 +𝑖𝑖)+ 𝑠𝑠+ 𝑠𝑠𝑖𝑖)𝑠𝑠𝑠𝑠
𝑖𝑖)𝑖𝑖) 𝐼𝐼𝑡𝑡 𝐼𝐼=𝑡𝑡 𝐼𝐼𝐼𝐼= 𝑡𝑡 =
𝑡𝑡𝑖𝑖𝐵𝐵 = 𝑖𝑖𝐵𝐵
𝑡𝑡−1 𝑖𝑖𝐵𝐵
𝑖𝑖𝐵𝐵
𝑡𝑡−1
> Convexity(Liabilities)
𝑡𝑡−1
𝑡𝑡−1
(iii) 𝑃𝑃"𝐴𝐴Fund
Sinking > 𝑃𝑃"Balance
𝐿𝐿 t =𝐿𝐿∑𝑆𝑆𝐹𝐹 𝑡𝑡 =𝑡𝑡 𝐷𝐷𝑠𝑠𝑡𝑡|
>
̅ 𝑗𝑗 𝑃𝑃𝑃𝑃𝑡𝑡+1
𝑃𝑃𝑡𝑡+1
+⋯+𝑃𝑃 +⋯+𝑃𝑃
𝑡𝑡+1 +⋯+𝑃𝑃
+⋯+𝑃𝑃 𝑡𝑡𝑡𝑡+𝑚𝑚
𝑡𝑡+𝑚𝑚 𝑡𝑡+𝑚𝑚
𝑡𝑡+𝑚𝑚

∑ 𝐼𝐼𝑡𝑡 = 𝑛𝑛𝑛𝑛 − 𝐿𝐿 ∑ 𝑃𝑃𝑡𝑡 = 𝐿𝐿 𝐵𝐵𝑡𝑡 = 𝐵𝐵𝑡𝑡−1 − 𝑃𝑃𝑡𝑡 Variable Notional Values: 𝑅𝑅(∑ 𝑄𝑄𝑡𝑡 𝑃𝑃𝑡𝑡 ) = ∑ 𝑄𝑄𝑡𝑡 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] 𝑃𝑃𝑡𝑡
∑∑ Full
𝐼𝐼∑∑
𝑡𝑡 𝐼𝐼= Immunization:
𝑡𝑡 𝐼𝐼𝐼𝐼𝑡𝑡=
𝑡𝑡 =
𝑛𝑛𝑛𝑛=𝑛𝑛𝑛𝑛− 𝑛𝑛𝑛𝑛
𝑛𝑛𝑛𝑛 −𝐿𝐿− 𝐿𝐿 𝐿𝐿𝐿𝐿 Full
− (i)
∑ Immunization:
∑and
∑
𝑃𝑃∑ 𝑡𝑡 𝑃𝑃= (ii)
𝑃𝑃=
𝑡𝑡𝑃𝑃 𝑡𝑡 =
𝑡𝑡𝐿𝐿 = as
𝐿𝐿 𝐿𝐿𝐿𝐿above, (i)𝐵𝐵and 𝑡𝑡(iii)
𝐵𝐵= 𝐵𝐵𝑡𝑡=
𝑡𝑡𝐵𝐵 𝑡𝑡(ii)
One
𝐵𝐵 = = as
𝐵𝐵−
𝐵𝐵
𝐵𝐵𝑡𝑡−1
𝑡𝑡−1 Asset
𝑡𝑡−1
𝑡𝑡−1
above,
𝑃𝑃𝑡𝑡−
− −𝑃𝑃𝑡𝑡𝑃𝑃𝑃𝑃cash
𝑡𝑡𝑡𝑡
(iii)inflow
One Asset beforecash eachinflow Net
Liability before
Amount cashof eachInterest
outflow Liability
andpaid
Variable
Variable cash
one
Variable outflow
in Notional
Variable year
after t it.
Notional
Notional
Notional and
= 𝐼𝐼𝑡𝑡Values:
=Values:
𝑖𝑖𝑖𝑖 one
Values:
Values: − 𝑗𝑗(𝑆𝑆𝐹𝐹 after
𝑅𝑅(∑ 𝑄𝑄𝑡𝑡it.
𝑅𝑅(∑
𝑅𝑅(∑
𝑅𝑅(∑
𝑡𝑡−1 )𝑃𝑃𝑡𝑡𝑄𝑄𝑡𝑡𝑄𝑄)𝑃𝑃
𝑄𝑄 )𝑃𝑃𝑡𝑡𝑡𝑡)=
𝑡𝑡𝑡𝑡𝑡𝑡𝑃𝑃
= )=
∑ =∑𝑡𝑡∑𝑄𝑄
𝑄𝑄 ∑𝑓𝑓𝑡𝑡𝑄𝑄 𝑄𝑄𝑓𝑓𝑡𝑡𝑡𝑡[𝑡𝑡−1,𝑡𝑡]
[𝑡𝑡−1,𝑡𝑡] 𝑓𝑓𝑓𝑓[𝑡𝑡−1,𝑡𝑡]
𝑃𝑃𝑡𝑡 𝑃𝑃𝑡𝑡𝑃𝑃𝑃𝑃𝑡𝑡𝑡𝑡
[𝑡𝑡−1,𝑡𝑡]
𝐵𝐵𝑡𝑡 = 𝑅𝑅𝑎𝑎𝑛𝑛−𝑡𝑡| ̅̅̅̅̅̅̅ (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃) 𝐵𝐵𝑡𝑡 = 𝐿𝐿(1 + 𝑖𝑖)𝑡𝑡 − 𝑅𝑅𝑠𝑠𝑡𝑡|̅ (𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅) Principal Repaid in year t = 𝑃𝑃𝑡𝑡 = 𝑆𝑆𝐹𝐹𝑡𝑡 − 𝑆𝑆𝐹𝐹𝑡𝑡−1 = 𝐷𝐷 + 𝑗𝑗(𝑆𝑆𝐹𝐹𝑡𝑡−1 )
𝑡𝑡+ 𝑡𝑡𝑖𝑖)𝑡𝑡𝑡𝑡 − 𝑅𝑅𝑠𝑠 ̅ Match boththe thetime amount and the
𝐵𝐵𝑡𝑡𝐵𝐵= 𝐵𝐵𝑡𝑡=
Exact
𝑡𝑡𝐵𝐵 𝑡𝑡 =
𝑅𝑅𝑎𝑎 =𝑅𝑅𝑎𝑎 𝑅𝑅𝑎𝑎
Matching
𝑅𝑅𝑎𝑎
̅̅̅̅̅̅̅ ̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
̅̅̅̅̅̅̅
𝑛𝑛−𝑡𝑡|
𝑛𝑛−𝑡𝑡|𝑛𝑛−𝑡𝑡|
𝑛𝑛−𝑡𝑡| Exact
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
or Matching
Dedication: 𝐵𝐵𝑡𝑡𝐵𝐵= 𝑡𝑡𝐵𝐵𝐵𝐵𝑡𝑡=
𝐿𝐿(1 = =
𝑡𝑡Match𝐿𝐿(1 or 𝐿𝐿(1
𝐿𝐿(1
+ Dedication:
𝑖𝑖)+
+ both
𝑖𝑖)− 𝑖𝑖)− 𝑅𝑅𝑠𝑠 −the ̅𝑅𝑅𝑠𝑠
𝑅𝑅𝑠𝑠
𝑡𝑡| ̅amount
𝑡𝑡| (𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅)
and
(𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅)
(𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅)
̅𝑡𝑡| (𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅)
𝑡𝑡| of Assets andtime of Assets and Liabilities
Liabilities
Sinking Fund Method:
Sinking Sinking
Sinking
Sinking LoanFund Fund
𝐿𝐿, Fund
Fund
SFMethod: Method:
Method:
Method:
Deposit D, Interest on Loan 𝑖𝑖, Interest on SF 𝑗𝑗
Loan Loan Loan
Loan 𝐿𝐿, 𝐿𝐿, SF 𝐿𝐿,
𝐿𝐿,SF SF SF
Deposit Deposit
Deposit
Deposit D,D, D,
D,
InterestInterest
Interest
Interest onon onon
Loan Loan Loan
Loan Interest
Interest
𝑖𝑖,𝑖𝑖,Interest
𝑖𝑖, 𝑖𝑖,Interest onon on
SF on SF 𝑗𝑗SF
SF 𝑗𝑗 𝑗𝑗𝐿𝐿𝑗𝑗 1 1
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 = 𝐼𝐼 + 𝐷𝐷 𝐼𝐼 = 𝑖𝑖𝑖𝑖 𝐿𝐿 = 𝐷𝐷𝑠𝑠𝑛𝑛| ̅̅̅𝑗𝑗 𝐷𝐷INTEREST
𝐿𝐿=𝐿𝐿𝑠𝑠𝐿𝐿̅̅̅ 𝐿𝐿 1 INTEREST 11̅̅̅ =INTEREST
1𝑎𝑎RATE 𝑖𝑖1+SWAPS1𝑠𝑠11 RATERATE SWAPS SWAPS
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 == 𝐼𝐼 ==
+𝐼𝐼 + 𝐼𝐼 + 𝐷𝐷
𝐼𝐼𝐷𝐷+𝐷𝐷𝐷𝐷𝐼𝐼 =𝐼𝐼 𝐼𝐼= 𝐼𝐼 = 𝑖𝑖𝑖𝑖
𝑖𝑖𝑖𝑖=𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝐿𝐿 = 𝐿𝐿 𝐿𝐿= 𝐿𝐿 =
=𝐷𝐷𝑠𝑠
𝐷𝐷𝑠𝑠 𝐷𝐷𝑠𝑠
̅̅̅𝐷𝐷𝑠𝑠
𝑛𝑛| 𝑗𝑗𝑛𝑛| 𝑗𝑗𝑛𝑛|𝑗𝑗𝑗𝑗 𝐷𝐷 𝐷𝐷
̅̅̅
̅̅̅𝑛𝑛| ̅̅̅ =𝐷𝐷== 𝐷𝐷 = 𝑛𝑛| 𝑗𝑗 == 𝑛𝑛| 𝑖𝑖 =
𝑖𝑖 = 𝑖𝑖 +
𝑖𝑖 + 𝑛𝑛|
+𝑖𝑖 + ̅̅̅𝑖𝑖
Sinking Fund Balance at time t = 𝑆𝑆𝐹𝐹𝑡𝑡 = 𝐷𝐷𝑠𝑠𝑡𝑡|̅ 𝑗𝑗 𝑠𝑠̅̅̅𝑠𝑠̅̅̅𝑠𝑠𝑠𝑠̅̅̅
1−𝑃𝑃𝑛𝑛 𝑛𝑛|𝑗𝑗𝑛𝑛|𝑛𝑛|
̅̅̅𝑗𝑗𝑗𝑗
𝑗𝑗𝑛𝑛| 𝑎𝑎𝑛𝑛|
̅̅̅ 𝑎𝑎𝑎𝑎𝑛𝑛|
𝑎𝑎𝑖𝑖𝑛𝑛|
̅̅̅ ̅̅̅1−𝑃𝑃 𝑠𝑠𝑛𝑛|
̅̅̅𝑖𝑖𝑖𝑖
𝑖𝑖𝑛𝑛| 𝑠𝑠𝑠𝑠𝑛𝑛|
̅̅̅𝑠𝑠𝑖𝑖𝑛𝑛|
̅̅̅ ̅̅̅𝑖𝑖𝑖𝑖
̅̅̅
𝑖𝑖𝑛𝑛| ∑ 𝑄𝑄 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] 𝑃𝑃𝑡𝑡 ∑ 𝑄𝑄 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] 𝑃𝑃𝑡𝑡
Constant
Sinking
Sinking Fund
Fund Notional Balance
Balance Constant
atValue:
at
at time
time =tNotional
t n-year t= = swap
𝑆𝑆𝐹𝐹 = Value: rate ̅𝑗𝑗𝑗𝑗 𝑅𝑅 n-year
= ∑ swap rate 𝑅𝑅 = ∑ 𝑛𝑛 NotionalVariable
Variable Values: Notional𝑅𝑅 = 𝑡𝑡∑ Values: 𝑅𝑅 = 𝑡𝑡∑
Sinking
Sinking Fund Fund Balance
Balance at
timetime =t𝑆𝑆𝐹𝐹 𝑡𝑡 𝑆𝑆𝐹𝐹
𝑆𝑆𝐹𝐹 = 𝑡𝑡 = 𝑡𝑡 =
𝑡𝑡𝐷𝐷𝑠𝑠 𝐷𝐷𝑠𝑠
𝑡𝑡| 𝑗𝑗𝐷𝐷𝑠𝑠
̅𝐷𝐷𝑠𝑠 ̅ 𝑗𝑗𝑡𝑡|
𝑡𝑡| ̅𝑡𝑡| 𝑃𝑃𝑖𝑖 𝑃𝑃𝑖𝑖 𝑄𝑄𝑡𝑡 𝑃𝑃𝑡𝑡 𝑄𝑄𝑡𝑡 𝑃𝑃𝑡𝑡
Net Amount of Interest paid in year t = 𝐼𝐼𝑡𝑡 𝑃𝑃=−𝑃𝑃𝑖𝑖𝑖𝑖 − 𝑗𝑗(𝑆𝑆𝐹𝐹𝑡𝑡−1 ) 𝑃𝑃𝑡𝑡−𝑃𝑃𝑡𝑡+𝑚𝑚 (1+𝑟𝑟
−𝑡𝑡 𝑡𝑡 )
𝑡𝑡 𝑃𝑃𝑡𝑡−1 (1+𝑟𝑟𝑡𝑡 )
𝑡𝑡 𝑃𝑃
Net t-year
Net Net
Net
Amount AmountAmount deferred
Amount of of of
of
Interest m-year
Interest t-year
Interest
Interest paid
paid deferred
swap
paid
paid
in in year in
in rate:
year year
year t= m-year
t𝑅𝑅= t𝐼𝐼t𝑡𝑡= =𝐼𝐼= 𝐼𝐼
𝐼𝐼=𝑖𝑖𝑖𝑖
𝑡𝑡 =swap
= 𝑡𝑡
𝑖𝑖𝑖𝑖
−
𝑡𝑡+𝑚𝑚
𝑖𝑖𝑖𝑖
𝑖𝑖𝑖𝑖
𝑡𝑡 +⋯+𝑃𝑃 𝑡𝑡−1𝑡𝑡−1 − −
𝑗𝑗(𝑆𝑆𝐹𝐹 − rate:
𝑗𝑗(𝑆𝑆𝐹𝐹
𝑗𝑗(𝑆𝑆𝐹𝐹
𝑗𝑗(𝑆𝑆𝐹𝐹 ) 𝑅𝑅
𝑡𝑡−1) =) )
𝑡𝑡−1 𝑃𝑃𝑡𝑡+1 +⋯+𝑃𝑃𝑡𝑡+𝑚𝑚 𝑃𝑃 𝑡𝑡 = (1 + 𝑟𝑟 𝑡𝑡 ) −𝑡𝑡 𝑃𝑃
𝑓𝑓𝑡𝑡 = (1
[𝑡𝑡−1,𝑡𝑡] =+ 𝑟𝑟𝑡𝑡 ) 𝑓𝑓
− 1
[𝑡𝑡−1,𝑡𝑡] = = − 1 𝑡𝑡−1
− 1 = 𝑡𝑡−1 − 1
Principal Repaid in year t = 𝑃𝑃𝑡𝑡 = 𝑆𝑆𝐹𝐹𝑡𝑡 −𝑡𝑡 𝑃𝑃𝑆𝑆𝐹𝐹 (1+𝑟𝑟𝑡𝑡−1 )𝑡𝑡−1 𝑃𝑃𝑡𝑡(1+𝑟𝑟𝑡𝑡−1 ) 𝑃𝑃𝑡𝑡
𝑡𝑡+1
𝑡𝑡−1 = 𝑡𝑡+𝑚𝑚 𝐷𝐷 + 𝑗𝑗(𝑆𝑆𝐹𝐹𝑡𝑡−1 )
Principal Principal
Principal
Principal Repaid
Repaid Repaid
Repaid in in yearin
inyear year
year
t =t = t𝑃𝑃t𝑡𝑡==𝑃𝑃= 𝑃𝑃𝑡𝑡=
𝑡𝑡𝑃𝑃 𝑡𝑡 =
𝑆𝑆𝐹𝐹 = 𝑡𝑡 𝑆𝑆𝐹𝐹
𝑆𝑆𝐹𝐹 𝑆𝑆𝐹𝐹
− 𝑡𝑡 − 𝑡𝑡 −
𝑡𝑡𝑆𝑆𝐹𝐹 − 𝑆𝑆𝐹𝐹
𝑆𝑆𝐹𝐹
𝑆𝑆𝐹𝐹
𝑡𝑡−1 𝑡𝑡−1 = 𝑡𝑡−1
𝑡𝑡−1 =𝐷𝐷= = +𝐷𝐷𝐷𝐷
𝐷𝐷 + + +
𝑗𝑗(𝑆𝑆𝐹𝐹 𝑗𝑗(𝑆𝑆𝐹𝐹
𝑗𝑗(𝑆𝑆𝐹𝐹
𝑗𝑗(𝑆𝑆𝐹𝐹𝑡𝑡−1𝑡𝑡−1 )𝑡𝑡−1) ))
𝑡𝑡−1
Callable Bonds - To calculate appropriate price: 𝐵𝐵 𝐵𝐵 +𝐶𝐶 𝐵𝐵 +𝐶𝐶
If Bond is sold at a Premium, assumeEXAM FM – 2017 NEW SYLLABUS – a1Review1
0 1 𝑛𝑛−1 𝑛𝑛−1
Early Redemption date If Bond is sold at Discount, assume Late Redemption date
If Bond is sold at a Discount, assume Late Redemption date Price of a Stock - Dividend Discount Model:
Bonds BONDS 𝐷𝐷
st 𝑃𝑃 = , Level dividends
BONDS
nd
1nd Column
Price Formulas: Number of Payments 𝑛𝑛, Interest Rate 𝑖𝑖, Coupon Rate 2 Column
𝑖𝑖
𝑟𝑟, Face 𝐷𝐷 Value 𝐹𝐹 , Redemption Value 𝐶𝐶
Column
2Price Formulas: Number of coupon payments 𝑛𝑛, Coupon If 𝑃𝑃𝑔𝑔=>𝑖𝑖−𝑘𝑘 , Dividends increasing at = rate 𝑘𝑘% with (𝐹𝐹𝐹𝐹first 𝐷𝐷 at̅̅̅time 1, 𝑘𝑘 < 𝑖𝑖
𝑔𝑔 rate 𝑟𝑟 𝑖𝑖, then 𝑃𝑃 > 𝐶𝐶 𝐹𝐹𝐹𝐹 and Premium 𝑃𝑃 − 𝐶𝐶 = − 𝐶𝐶𝐶𝐶)𝑎𝑎 𝑛𝑛| = (𝐶𝐶𝐶𝐶 − 𝐶𝐶𝐶𝐶)𝑎𝑎̅̅̅ 𝑛𝑛|
If𝑃𝑃
𝑃𝑃 = 𝑔𝑔 >
= 𝐹𝐹𝐹𝐹𝑎𝑎
𝐹𝐹𝐹𝐹𝑎𝑎 then
𝑖𝑖, 𝑛𝑛|
̅̅̅ ++ 𝑃𝑃
𝐶𝐶𝑣𝑣
𝐶𝐶𝑣𝑣 >𝑛𝑛 𝐶𝐶 and
𝑛𝑛
𝑃𝑃 Premium
=𝑃𝑃 𝐶𝐶
= +𝐶𝐶 (𝐹𝐹𝐹𝐹
+ =−
(𝐹𝐹𝐹𝐹 𝑃𝑃 −
𝐶𝐶𝐶𝐶)𝑎𝑎
− 𝐶𝐶
𝐶𝐶𝐶𝐶)𝑎𝑎
̅̅̅= (𝐹𝐹𝐹𝐹 −𝑃𝑃 𝐶𝐶𝐶𝐶)𝑎𝑎
= 𝐾𝐾 +
̅̅̅
𝑛𝑛| = (𝐶𝐶𝐶𝐶
(𝐶𝐶 − − 𝐾𝐾),𝐶𝐶𝐶𝐶)𝑎𝑎 ̅̅̅
𝑛𝑛| 𝐾𝐾 = 𝐶𝐶𝑣𝑣 𝑛𝑛
, 𝑔𝑔 =
̅̅̅
𝑛𝑛| 𝑛𝑛| ̅̅̅
𝑛𝑛| 𝑖𝑖 Amortization of Premium 𝐶𝐶 Amount: 𝑃𝑃𝑡𝑡 = 𝐹𝐹𝐹𝐹 − 𝐼𝐼𝑡𝑡 = 𝐵𝐵𝑡𝑡−1 − 𝐵𝐵𝑡𝑡 = (𝐹𝐹𝐹𝐹 − 𝐶𝐶𝐶𝐶)𝑣𝑣 𝑛𝑛−𝑡𝑡+1
Amortization 𝑔𝑔 of Premium Amount: = 𝐹𝐹𝐹𝐹 − 𝐼𝐼𝑡𝑡 = 𝐵𝐵𝑡𝑡−1 − 𝐵𝐵𝑡𝑡 = (𝐹𝐹𝐹𝐹 − 𝐶𝐶𝐶𝐶)𝑣𝑣Spot Rates: Effective annual yield rate on𝑛𝑛−𝑡𝑡
𝑃𝑃𝑡𝑡 𝐹𝐹𝐹𝐹 𝑛𝑛−𝑡𝑡+1 investment for 𝑡𝑡 years, 𝑟𝑟𝑡𝑡
𝑃𝑃 =
If 𝑔𝑔 𝐾𝐾 +𝑖𝑖, then (𝐶𝐶 − 𝐾𝐾),𝐶𝐶 and 𝐾𝐾 =Premium 𝐶𝐶𝑣𝑣 𝑛𝑛 , 𝑔𝑔==𝑃𝑃 − 𝐶𝐶𝑛𝑛−𝑡𝑡 (𝐹𝐹𝐹𝐹 − 𝐶𝐶𝐶𝐶)𝑎𝑎𝑛𝑛| ̅̅̅ = (𝐶𝐶𝐶𝐶 − 𝐶𝐶𝐶𝐶)𝑎𝑎𝑛𝑛|
Book Amount Value: for 𝐵𝐵𝑡𝑡Amortization
= zero-coupon
𝐵𝐵𝑡𝑡−1 − 𝑃𝑃𝑡𝑡 of = 𝐹𝐹𝐹𝐹𝑎𝑎
Premium 𝑛𝑛−𝑡𝑡|𝑃𝑃+= 𝐶𝐶𝑣𝑣𝑃𝑃 =+𝐹𝐹𝐹𝐹 𝑛𝑛−𝑡𝑡+1
>Value: 𝑃𝑃 > 𝐶𝐶𝑣𝑣 = 𝑟𝑟𝑡𝑡 )− 𝑡𝑡−1 − 𝐵𝐵𝑡𝑡 = (𝐹𝐹𝐹𝐹 − 𝐶𝐶𝐶𝐶)𝑣𝑣
̅̅̅Price ̅̅̅̅̅̅̅ −𝑡𝑡𝐼𝐼 = 𝐵𝐵
Book 𝑖𝑖 𝐵𝐵𝑡𝑡 = 𝐵𝐵𝑡𝑡−1 − 𝑃𝑃𝑡𝑡 = 𝐹𝐹𝐹𝐹𝑎𝑎𝑛𝑛−𝑡𝑡| ̅̅̅̅̅̅̅ +𝐶𝐶
of a 𝑡𝑡-year Bond: 𝑡𝑡 = (1 𝑡𝑡 𝑡𝑡
Interest Earned = 𝐼𝐼 = 𝑖𝑖𝐵𝐵 Book Value = 𝐵𝐵 = 𝐵𝐵 − 𝑃𝑃 = 𝐹𝐹𝐹𝐹𝑎𝑎 ̅̅̅̅̅̅̅ + Interest
𝐶𝐶𝑣𝑣 𝑛𝑛−𝑡𝑡 Earned: 𝐼𝐼𝑡𝑡 = 𝑖𝑖𝐵𝐵𝑡𝑡−1
𝑑𝑑 𝑑𝑑
Interest Earned: 𝐼𝐼𝑡𝑡 𝑡𝑡= 𝑖𝑖𝐵𝐵𝑡𝑡−1 𝑡𝑡−1 𝑡𝑡 𝑡𝑡−1 𝑡𝑡 𝑛𝑛−𝑡𝑡|
𝑃𝑃 Annual) 𝑃𝑃
Price (1 + 𝑖𝑖)𝑘𝑘 , 0 < 𝑘𝑘 < 1− 𝐶𝐶𝐶𝐶)𝑎𝑎 𝐷𝐷Forward
∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 (Effective
Rates: 𝑑𝑑𝑑𝑑 ∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡+1 𝑑𝑑𝑑𝑑 = 𝐷𝐷
If 𝑔𝑔 <between𝑖𝑖, then 𝑃𝑃 < Coupon𝐶𝐶 and Discount Dates: 𝐵𝐵𝑡𝑡+𝑘𝑘 = 𝐶𝐶=−𝐵𝐵𝑃𝑃𝑡𝑡 =𝑘𝑘 (𝐶𝐶𝐶𝐶 − 𝐹𝐹𝐹𝐹)𝑎𝑎̅̅̅ 𝑛𝑛| = (𝐶𝐶𝐶𝐶 If
̅̅̅ (𝑖𝑖)
Amount
𝑔𝑔 < 𝑖𝑖, then
𝑚𝑚𝑚𝑚𝑚𝑚
𝑛𝑛|𝑚𝑚-year
=
forward
∑ for𝐴𝐴𝑃𝑃𝑡𝑡 𝑣𝑣<𝑡𝑡 rate,=
Accumulation
𝐶𝐶 and − Discount
deferred
𝑃𝑃 of 𝑡𝑡Discount𝐷𝐷
years:= 𝐶𝐶 − 𝑃𝑃 =
𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖) = = 𝑃𝑃 =
𝑡𝑡 (𝐶𝐶𝐶𝐶
∑ 𝐼𝐼𝑡𝑡 −
𝐴𝐴 −𝑣𝑣 𝐹𝐹𝐹𝐹 = =
𝑡𝑡𝐹𝐹𝐹𝐹)𝑎𝑎𝑛𝑛|
−
̅̅̅𝐵𝐵 𝑡𝑡=𝑃𝑃−(𝐶𝐶𝐶𝐶
𝐵𝐵𝑡𝑡−1 −𝑚𝑚𝑚𝑚𝑚𝑚 𝑣𝑣 ̅̅̅− 𝐹𝐹𝐹𝐹)𝑣𝑣 𝑛𝑛−𝑡𝑡+1
= (𝐶𝐶𝐶𝐶
𝐶𝐶𝐶𝐶)𝑎𝑎 𝑛𝑛|
Quoted
IfInterest
𝑔𝑔 < 𝑖𝑖, Earned Price:
then 𝑃𝑃 < 𝑄𝑄𝑡𝑡𝐶𝐶=and 𝐵𝐵 Discount − 𝑘𝑘𝑘𝑘𝑘𝑘 ==𝐵𝐵𝐶𝐶𝑡𝑡 (1 −+ 𝑃𝑃 = 𝑖𝑖) (𝐶𝐶𝐶𝐶 − 𝑘𝑘𝑘𝑘𝑘𝑘 ̅̅̅ (𝐶𝐶𝐶𝐶 − 𝐶𝐶𝐶𝐶)𝑎𝑎𝑛𝑛|
= 𝐵𝐵𝑡𝑡 −=𝐹𝐹𝐹𝐹)𝑎𝑎 𝐵𝐵𝑡𝑡−1𝑛𝑛|+=𝑃𝑃𝑡𝑡 = 𝐹𝐹𝐹𝐹𝑎𝑎 ̅̅̅ 𝑡𝑡
= 𝐼𝐼𝑡𝑡 = 𝑡𝑡+𝑘𝑘 𝑖𝑖𝐵𝐵𝑡𝑡−1 Book Value ̅̅̅̅̅̅̅ + 𝐶𝐶𝑣𝑣
Accumulation
𝑛𝑛−𝑡𝑡
𝑡𝑡 of 1+𝑖𝑖 𝑚𝑚
Discount Amount: 𝑃𝑃
𝑡𝑡+𝑚𝑚 = 𝐼𝐼 − 𝐹𝐹𝐹𝐹 = 𝐵𝐵 − 𝐵𝐵 = (𝐶𝐶𝐶𝐶 (𝐼𝐼𝐼𝐼)𝑛𝑛|
− 𝐹𝐹𝐹𝐹)𝑣𝑣
̅̅̅ 𝑛𝑛−𝑡𝑡+1
𝑛𝑛−𝑡𝑡| (1
Perpetuity:+
𝑛𝑛−𝑡𝑡+1 𝑟𝑟 ) (1 𝐷𝐷 + 𝑓𝑓 = ) = (1 + 𝑟𝑟 )
Mortgage 𝑡𝑡 𝑡𝑡or Level Annuity:
𝑡𝑡 𝑡𝑡−1𝐷𝐷 =
Accumulation of Discount Amount: 𝑃𝑃𝑡𝑡 = 𝐼𝐼𝑡𝑡 − 𝐹𝐹𝐹𝐹 = 𝐵𝐵𝑡𝑡 − 𝐵𝐵𝑡𝑡−1 = (𝐶𝐶𝐶𝐶 − 𝐹𝐹𝐹𝐹)𝑣𝑣 𝑡𝑡 𝑚𝑚𝑚𝑚𝑚𝑚 [𝑡𝑡,𝑡𝑡+𝑚𝑚] 𝑖𝑖 𝑡𝑡+𝑚𝑚 𝑚𝑚𝑚𝑚𝑚𝑚 𝑎𝑎̅̅̅
Callable
Price between BondsCoupon - To calculate appropriate price: 𝑘𝑘 Book Quoted Value:Price 𝐵𝐵𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼)
𝑡𝑡 ==𝐵𝐵 +𝑛𝑛 𝑃𝑃𝑘𝑘𝑘𝑘𝑘𝑘
𝑡𝑡 = 𝐹𝐹𝐹𝐹𝑎𝑎 (1 ++𝑖𝑖)𝐶𝐶𝑣𝑣− 𝑘𝑘𝑘𝑘𝑘𝑘𝑘𝑘 𝑛𝑛−𝑡𝑡 𝑛𝑛|
Book Value: 𝐵𝐵 = 𝐵𝐵 + Dates:
𝑃𝑃𝑡𝑡 = 𝐹𝐹𝐹𝐹𝑎𝑎 𝑡𝑡+𝑘𝑘 = 𝐵𝐵𝑡𝑡 (1
𝐵𝐵̅̅̅̅̅̅̅
𝑛𝑛−𝑡𝑡| + 𝐶𝐶𝑣𝑣
𝑛𝑛−𝑡𝑡+ 𝑖𝑖) , 0 < 𝑘𝑘 < 1 One-year
Bond: 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 forward
=
̅̅̅𝐵𝐵
𝑡𝑡−1
rate,
𝑛𝑛| 𝑡𝑡+𝑘𝑘 −
+𝑛𝑛𝑛𝑛𝑣𝑣
deferred = 𝐵𝐵𝑡𝑡𝑛𝑛−𝑡𝑡|
̅̅̅̅̅̅̅
𝑡𝑡 years:
Bond Sold at Par: 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑎𝑎̈ 𝑛𝑛|
If Bond is sold 𝑡𝑡at a 𝑡𝑡−1 Premium, assume Early Redemption date Interest Earned: 𝐼𝐼 𝑃𝑃= 𝑖𝑖𝐵𝐵𝑡𝑡−1 𝑃𝑃
̅̅̅
Interest Earned: 𝐼𝐼𝑡𝑡 = 𝑖𝑖𝐵𝐵𝑡𝑡−1 𝑓𝑓[𝑡𝑡,𝑡𝑡+1]
(1+𝑟𝑟
= Early 𝑡𝑡+1 ) 𝑡𝑡+1
𝑡𝑡
− 1 = If−Bond 𝑡𝑡
1 is sold at a Discount, assume Late Redemption.
If Bond isBonds
Callable sold at-aToDiscount, Calculateassume Appropriate LatePrice: Redemption If Bond isdate sold at a Premium, assume (1+𝑟𝑟𝑡𝑡 )Redemption;
𝑡𝑡 𝑃𝑃𝑡𝑡+1
Convexity:
𝑑𝑑2 𝑑𝑑2
GENERAL CASH FLOWS ∑ 𝑡𝑡 2 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 𝑑𝑑𝛿𝛿 2 𝑃𝑃 ∑ 𝑡𝑡(𝑡𝑡 + 1)𝐴𝐴𝑡𝑡GENERAL 𝑣𝑣 𝑡𝑡+2 𝑑𝑑𝑖𝑖 2 𝑃𝑃 CASH 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 +FLOWS 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚
General
2
nd
Column Cash Flows GENERAL
nd =
𝐶𝐶2𝑚𝑚𝑚𝑚𝑚𝑚
CASH Column FLOW = 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 = = =
st ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 𝑃𝑃 ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 𝑃𝑃 (1 + 𝑖𝑖)2
1If > 𝑖𝑖, then 𝑃𝑃 > 𝐶𝐶 and Premium = 𝑃𝑃 − 𝐶𝐶 = (𝐹𝐹𝐹𝐹 − 𝐶𝐶𝐶𝐶)𝑎𝑎𝑛𝑛|
𝑔𝑔Column ̅̅̅ = (𝐶𝐶𝐶𝐶 − 𝐶𝐶𝐶𝐶)𝑎𝑎 1 𝑛𝑛| ̅̅̅ Column
st
Reinvestment Rates:
Amortization
Reinvestment
- A single deposit of
Rates: Premium
of $1, Interest
𝑑𝑑 interest Amount:
rate rate 𝑖𝑖, Reinvestment
𝑖𝑖, 𝑃𝑃 =
reinvestment
𝑡𝑡 𝐹𝐹𝐹𝐹 − 𝐼𝐼𝑡𝑡 =rate 𝐵𝐵
rate 𝑖𝑖′
𝑡𝑡−1 𝑖𝑖′:− 𝑑𝑑 𝐵𝐵
𝐴𝐴𝐴𝐴 𝑡𝑡 = (𝐹𝐹𝐹𝐹
1 + −
𝑖𝑖𝑠𝑠 Reinvestment
Inflation
𝐶𝐶𝐶𝐶)𝑣𝑣
̅̅̅
𝑛𝑛−𝑡𝑡+1 Rate: Rates:
Real rate Interest of interestrate 𝑖𝑖, 𝑖𝑖Reinvestment ′
, Inflation raterate 𝑟𝑟 𝑖𝑖′
𝑛𝑛|𝑖𝑖′
ABook single
-𝐷𝐷Deposits Value: ∑
deposit of 𝑡𝑡𝐴𝐴 𝐵𝐵
$1 𝑣𝑣of𝑡𝑡
𝑡𝑡 𝑡𝑡 at= $1,
𝐵𝐵
beginning 𝐴𝐴𝐴𝐴
𝑑𝑑𝑑𝑑 − 𝑃𝑃= 𝑃𝑃 1 = +
of 𝑖𝑖𝑠𝑠
𝐹𝐹𝐹𝐹𝑎𝑎
each ̅̅̅ ′
𝑛𝑛|𝑖𝑖𝑛𝑛−𝑡𝑡|
̅̅̅̅̅̅̅year,+ 𝐶𝐶𝑣𝑣 ∑
𝑛𝑛−𝑡𝑡
interest 𝑡𝑡𝐴𝐴 𝑣𝑣 𝑡𝑡+1
𝑡𝑡 rate 𝑖𝑖, reinvestment 𝑑𝑑𝑑𝑑
𝑃𝑃 A
rate single
Duration
1 +𝑖𝑖′: 𝑖𝑖 = 𝐴𝐴𝐴𝐴deposit
(1 of
= + a
𝑛𝑛 + of
Portfolio:
𝑖𝑖′)(1 $1,
+
𝑖𝑖(𝐼𝐼𝐼𝐼) 𝑟𝑟), 𝐴𝐴𝐴𝐴𝐷𝐷 𝑡𝑡= and1
𝑖𝑖 = + 𝑃𝑃𝑖𝑖 𝑖𝑖𝑠𝑠
′ are
+ ̅̅̅
𝑡𝑡 𝑛𝑛|𝑖𝑖 𝑟𝑟′ duration
+ 𝑖𝑖 ′ 𝑟𝑟 and price of components of Portfolio
𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖) = =− 𝑡𝑡−1 𝑡𝑡 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖) = ̅̅̅
𝑡𝑡 = −
= 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 𝑣𝑣 𝑛𝑛| 𝑖𝑖′
Deposits
Interest Earned: of∑$1 𝐴𝐴𝑡𝑡at𝑣𝑣 𝑡𝑡 beginning
𝐼𝐼𝑡𝑡 = 𝑖𝑖𝐵𝐵 𝑃𝑃 of each year, 𝐴𝐴𝐴𝐴 = ∑ 𝑛𝑛 𝐴𝐴+𝑡𝑡 𝑣𝑣𝑖𝑖(𝐼𝐼𝐼𝐼) ̅̅̅𝑖𝑖 ′ 𝑃𝑃
𝑛𝑛| Deposits
𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃) of $1=at𝐷𝐷1beginning 𝑃𝑃1 + 𝐷𝐷2 𝑃𝑃2 + of⋯each + 𝐷𝐷𝑛𝑛year, 𝑃𝑃𝑛𝑛 𝐴𝐴𝐴𝐴 = 𝑛𝑛 + 𝑖𝑖(𝐼𝐼𝐼𝐼)𝑛𝑛| ̅̅̅𝑖𝑖 ′
𝑡𝑡−1
Perpetuity: 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 =Method: A is initial
Dollar-Weighted 1+𝑖𝑖
Mortgagebalance, orBLevel is ending Annuity: balance, (𝐼𝐼𝐼𝐼)𝑛𝑛| Duration:
𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 =𝐶𝐶𝑡𝑡 is contribution at time 𝑡𝑡. 𝑑𝑑𝑖𝑖𝐷𝐷 = 𝐴𝐴+∑ 𝐶𝐶𝑡𝑡 (1−𝑡𝑡)
̅̅̅ 𝑃𝑃 1 + 𝑃𝑃 2 + ⋯ 𝐵𝐵−𝐴𝐴−∑ 𝐶𝐶𝑡𝑡
+ 𝑃𝑃 𝑛𝑛
𝑑𝑑
𝑖𝑖 𝑎𝑎𝑛𝑛|
∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡Rate of 𝑃𝑃 𝑡𝑡+1 𝑃𝑃
Dollar-Weighted <Rate of𝑛𝑛Discount
Return: = 𝐶𝐶 − 𝑃𝑃 = (𝐶𝐶𝐶𝐶 − 𝐹𝐹𝐹𝐹)𝑎𝑎𝑛𝑛| Dollar-Weighted 𝑑𝑑𝑑𝑑 Return: 𝐷𝐷 𝐵𝐵 (𝑖𝑖) 𝐵𝐵= ∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 )𝐵𝐵= − 𝑑𝑑𝑑𝑑 = 𝐷𝐷
̅̅̅
If 𝑔𝑔 < 𝑖𝑖, then 𝑃𝑃 𝐶𝐶𝑛𝑛| and ̅̅̅ = (𝐶𝐶𝐶𝐶 − 𝐶𝐶𝐶𝐶)𝑎𝑎 ̅̅̅
𝑛𝑛|
𝐷𝐷 (𝑖𝑖) = = −
Bond: 𝐵𝐵−𝐴𝐴−∑ 𝐶𝐶
𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼) ̅̅̅ +𝑛𝑛𝑛𝑛𝑣𝑣
Bond Sold at Par: First-Order
𝑚𝑚𝑚𝑚𝑚𝑚𝐵𝐵−𝐴𝐴−∑ 𝐶𝐶Modified Price Approximation: 𝑃𝑃(𝑖𝑖) ≈ 𝑃𝑃(𝑖𝑖 −
𝑛𝑛 𝑃𝑃(𝑖𝑖0 )(𝑖𝑖 − 𝑖𝑖0𝑚𝑚𝑚𝑚𝑚𝑚 )𝐷𝐷 𝑣𝑣 (𝑖𝑖 )
Time-Weighted
𝑖𝑖Accumulation 𝐷𝐷
𝐷𝐷 = 𝐴𝐴+∑𝑚𝑚𝑚𝑚𝑚𝑚
= 𝑡𝑡 Method:
, Initial 𝑃𝑃 balance
𝐵𝐵𝑡𝑡 isA,balance Ending𝑃𝑃at time 𝑡𝑡 before
balance 𝐷𝐷
B, Contribution any contribution,
𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑎𝑎̈ ̅̅̅ 𝐶𝐶 𝐶𝐶=
𝑡𝑡 (𝐶𝐶𝐶𝐶 −𝑖𝑖𝐷𝐷𝐹𝐹𝐹𝐹)𝑣𝑣 𝑡𝑡 is 𝑛𝑛−𝑡𝑡+1
contribution ∑ 𝐴𝐴𝑡𝑡, 𝑣𝑣Initial
𝑡𝑡 𝑡𝑡 at time balance 𝑃𝑃𝑡𝑡. 1A, + Ending 𝑚𝑚𝑚𝑚𝑚𝑚
𝑖𝑖𝑇𝑇 = ∙balance 1 2
∙∑…𝐴𝐴B, ∙𝑡𝑡 𝑣𝑣Contribution
0
𝑡𝑡 𝑃𝑃 𝐶𝐶𝑡𝑡 𝑚𝑚𝑚𝑚𝑚𝑚 0
𝐶𝐶𝑡𝑡 (1−𝑡𝑡) of Discount Amount: 𝑛𝑛|
𝑡𝑡 = 𝐼𝐼𝑡𝑡 − 𝐹𝐹𝐹𝐹 = 𝐵𝐵𝑡𝑡 − 𝐵𝐵𝑡𝑡−1 = 𝐴𝐴+∑ 𝐶𝐶𝑡𝑡 (1−𝑡𝑡) 1+𝑖𝑖
𝐵𝐵0 𝐵𝐵1 +𝐶𝐶1 𝐵𝐵𝑛𝑛−1 +𝐶𝐶𝑛𝑛−1
(𝐼𝐼𝐼𝐼)𝑛𝑛|
̅̅̅
Book
Price Value:
of a Stock 𝐵𝐵𝑡𝑡 =- Dividend 𝐵𝐵𝑡𝑡−1 + 𝑃𝑃𝑡𝑡 Discount = 𝐹𝐹𝐹𝐹𝑎𝑎𝑛𝑛−𝑡𝑡| + 𝐶𝐶𝑣𝑣 𝑛𝑛−𝑡𝑡 𝑃𝑃 = 𝐷𝐷 (𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷)
̅̅̅̅̅̅̅ Model: Perpetuity: 𝑃𝑃 = 𝐷𝐷
𝐷𝐷 𝑚𝑚𝑚𝑚𝑚𝑚 =
(𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Mortgage or
𝑘𝑘%Level Annuity:
1+𝑖𝑖0 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚
(𝑖𝑖0 ) =
Convexity: First-Order Macaulay 𝑖𝑖 Price𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼
Approximation: 𝑎𝑎𝑎𝑎 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑃𝑃(𝑖𝑖) ≈ 𝑤𝑤𝑤𝑤𝑤𝑤ℎ
𝑃𝑃(𝑖𝑖 )𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓
( 𝐷𝐷
) 𝑎𝑎𝑡𝑡 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 1, 𝑘𝑘 < 𝑖𝑖)
𝑎𝑎𝑛𝑛|
̅̅̅
0
Time-Weighted Method: 𝑖𝑖 𝑖𝑖−𝑘𝑘
𝑑𝑑2𝑖𝑖 ′ real rateTime-Weighted Method: 1+𝑖𝑖
Interest 𝐵𝐵Earned: 𝐼𝐼𝑡𝑡𝑑𝑑2= 𝑖𝑖𝐵𝐵𝐵𝐵𝑡𝑡−1 𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼) ̅̅̅ +𝑛𝑛𝑛𝑛𝑣𝑣
𝑛𝑛

ofBond: Bond Sold at Par: 𝐷𝐷

𝑛𝑛|
where 𝐷𝐷𝐵𝐵𝑚𝑚𝑚𝑚𝑚𝑚
1 𝑟𝑟 = = 𝑎𝑎̈ 𝑛𝑛|
𝐷𝐷interest, inflation 𝑃𝑃∙rate 𝑛𝑛
′
1Inflation
+ 𝑖𝑖 𝑇𝑇 =∑ 𝑡𝑡Rate: 12 𝐵𝐵
∙ 𝐴𝐴𝑡𝑡 𝑣𝑣2𝑡𝑡 1∙+ … 𝑖𝑖 ∙=
2 𝑃𝑃
(1 𝑛𝑛+ 𝑖𝑖′)(1 + 𝑟𝑟), 𝑖𝑖 ∑
, Balance = 𝑖𝑖before
𝐵𝐵𝑡𝑡𝑡𝑡(𝑡𝑡 ++𝑟𝑟1)𝐴𝐴 + any 𝑖𝑖 ′𝑣𝑣𝑟𝑟,𝑡𝑡+2 contribution 2 𝑃𝑃
𝐵𝐵2 𝐵𝐵 ̅̅̅
𝐵𝐵 𝐵𝐵 +𝐶𝐶 𝑑𝑑𝛿𝛿 𝐵𝐵 +𝐶𝐶 𝑡𝑡 𝑑𝑑𝑖𝑖 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚
𝑡𝑡 +
1 + 𝑖𝑖
𝑚𝑚𝑚𝑚𝑚𝑚
𝑇𝑇 = ∙ ∙ … , Balance 𝐵𝐵𝑡𝑡 before any 𝑚𝑚𝑚𝑚𝑚𝑚 contribution 𝐶𝐶𝑡𝑡
𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 = 0 1 𝑡𝑡 1= 𝑛𝑛−1 𝑛𝑛−1 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 = = = 𝐵𝐵0 𝐵𝐵1 +𝐶𝐶1 𝐵𝐵𝑛𝑛−1 +𝐶𝐶𝑛𝑛−1
Spot Rates: ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣(Effective 𝑃𝑃 Annual) 𝑟𝑟𝑡𝑡 yield rate on ∑ 𝐴𝐴investment
𝑡𝑡 𝑣𝑣 𝑡𝑡
for 𝑃𝑃 𝑡𝑡 years. (1 + Price
𝑖𝑖) 2
of a 𝑡𝑡-year zero-coupon Bond 𝑃𝑃 𝑡𝑡 = (1 + 𝑟𝑟𝑡𝑡 ) −𝑡𝑡
IMMUNIZATION
Convexity:
Price of a Stock - Dividend Discount Model: GENERAL CASHPrice FLOWS of 𝑟𝑟a )Stock - Dividend Discount Model:
Forward Rates: (Effective Annual) 𝑚𝑚-year forward rate, deferred 𝑡𝑡 years: (1 𝑡𝑡 𝑑𝑑2 )𝑚𝑚 = (1 + 𝑟𝑟𝑡𝑡+𝑚𝑚 )𝑡𝑡+𝑚𝑚 𝑑𝑑2
𝐷𝐷 + ∑ (1 +𝑡𝑡 𝑓𝑓[𝑡𝑡,𝑡𝑡+𝑚𝑚]
𝐷𝐷
𝑃𝑃 = , Level dividends Redington 2 𝑃𝑃 (i) PV(Assets) =∑PV(Liabilities) 2 𝑃𝑃 (i) 𝑃𝑃𝐴𝐴 = 𝑃𝑃𝐿𝐿
𝑡𝑡 2Immunization: 𝑡𝑡+2
𝑃𝑃 = , Level 𝑡𝑡 𝐴𝐴 𝑣𝑣
dividends
𝑡𝑡 𝑑𝑑𝛿𝛿 𝑡𝑡(𝑡𝑡 + 1)𝐴𝐴 𝑡𝑡 𝑣𝑣 𝑑𝑑𝑖𝑖 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 + 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚
1Duration
st 𝑖𝑖
Column of a Portfolio: 𝐷𝐷𝑡𝑡 and 𝑃𝑃𝑡𝑡 are duration and price of components of Portfolio 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 𝑖𝑖 = = )𝑡𝑡+1 (ii) 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 =
Duration(Assets) = Duration(Liabilities) = =
𝑃𝑃 =
𝐷𝐷
, Dividends 𝐷𝐷1 𝑃𝑃1increasing
+ 𝐷𝐷2 𝑃𝑃2 + ⋯ at+rate 𝐷𝐷𝑛𝑛 𝑃𝑃𝑘𝑘%One-year with first forward𝐷𝐷 at time rate, 1,deferred
𝑘𝑘 < 𝑖𝑖 𝑡𝑡 years 𝐷𝐷𝑓𝑓 ∑ 𝐴𝐴=𝑡𝑡 𝑣𝑣 𝑡𝑡
(1+𝑟𝑟 𝑡𝑡+1 𝑃𝑃 − 1 = 𝑃𝑃𝑡𝑡
− 1 ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 𝑃𝑃 (1 + 𝑖𝑖)2(ii) 𝑃𝑃′𝐴𝐴 = 𝑃𝑃′𝐿𝐿
Reinvestment
𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
𝑖𝑖−𝑘𝑘 = Rates: Interest rate 𝑖𝑖, Reinvestment rate 𝑖𝑖′
𝑛𝑛 𝑃𝑃 = [𝑡𝑡,𝑡𝑡+1] , Dividends (1+𝑟𝑟𝑡𝑡 )increasing
𝑡𝑡 at rate 𝑘𝑘% with first
(iii)𝑃𝑃𝑡𝑡+1
Convexity(Assets) 𝐷𝐷 at time 1, 𝑘𝑘 < 𝑖𝑖
> Convexity(Liabilities) (iii) 𝑃𝑃"𝐴𝐴 > 𝑃𝑃
𝑖𝑖−𝑘𝑘
A single deposit of 𝑃𝑃$1, 1 +𝐴𝐴𝐴𝐴 𝑃𝑃2 + = ⋯1 + + 𝑃𝑃𝑛𝑛 ′
𝑑𝑑 𝑖𝑖𝑠𝑠𝑛𝑛|̅̅̅ 𝑖𝑖 𝑑𝑑
Spot Rates: Effective∑annual 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 yield 𝑑𝑑𝑑𝑑 rate on investment
𝑃𝑃 ∑ 𝑡𝑡𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡+1 for 𝑡𝑡 years, 𝑃𝑃 𝑟𝑟𝑡𝑡 (𝐼𝐼𝐼𝐼)𝑛𝑛|
Full Immunization: =(i) annual and𝐷𝐷(ii)and asMortgage
above, (iii) One Asset cash inflow before each Liability cash
1+𝑖𝑖 ̅̅̅
Duration:
Deposits
First-Order of𝐷𝐷Modified
$1 at (𝑖𝑖)beginning
= ∑Price =of − each year,
𝐷𝐷 (𝑖𝑖)
𝐴𝐴𝐴𝐴==)−𝑡𝑡 𝑛𝑛 +𝑣𝑣𝑡𝑡𝑖𝑖(𝐼𝐼𝐼𝐼) =− ̅̅̅ ′ = 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 𝑣𝑣 Spot
𝑑𝑑𝑑𝑑
Perpetuity:
Duration Rates: of Effective
𝐷𝐷
a 𝑚𝑚𝑚𝑚𝑚𝑚
Portfolio: 𝑡𝑡 yield 𝑃𝑃𝑡𝑡 rate
are duration on orinvestment
Level and Annuity:price forof 𝑡𝑡𝐷𝐷 years,
components
𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑟𝑟𝑡𝑡𝑎𝑎 of Portfolio
Price of a 𝑡𝑡-year 𝑚𝑚𝑚𝑚𝑚𝑚
zero-coupon 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 Approximation:
Bond: 𝑃𝑃 𝑃𝑃𝑡𝑡 𝑚𝑚𝑚𝑚𝑚𝑚
= (1 +𝑃𝑃(𝑖𝑖) 𝑟𝑟𝑡𝑡 ∑≈𝐴𝐴𝑡𝑡𝑃𝑃(𝑖𝑖 0 ) −𝑛𝑛| 𝑃𝑃(𝑖𝑖
𝑖𝑖 𝑃𝑃 0 )(𝑖𝑖 − 𝑖𝑖0 )𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖0 ) 𝑖𝑖 ̅̅̅
Price of a 𝑡𝑡-year 𝐹𝐹𝐹𝐹(𝐼𝐼𝐼𝐼) 𝐷𝐷1 𝑃𝑃1 ++𝑛𝑛𝑛𝑛𝑣𝑣
zero-coupon 𝐷𝐷2 𝑃𝑃𝑛𝑛2 +Bond: ⋯ + 𝐷𝐷𝑃𝑃 𝑛𝑛 𝑃𝑃𝑛𝑛= (1 + 𝑟𝑟𝑡𝑡 )
𝑡𝑡
−𝑡𝑡 𝑛𝑛|
𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
ExactBond:Matching 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 == or Dedication:
̅̅̅ MatchSold bothatthe amount 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 and the time of Assets and Liabilities
𝑃𝑃𝑃𝑃1 + 𝑃𝑃2 + ⋯Bond Par:
𝑛𝑛|
Dollar-Weighted Rate of Annual) Return: 1+𝑖𝑖0 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚(𝑖𝑖0 ) + 𝑃𝑃𝑛𝑛 = 𝑎𝑎̈ 𝑛𝑛|
̅̅̅
Forward
First-Order Rates: Macaulay (Effective Price Approximation: 𝑃𝑃(𝑖𝑖) ≈ 𝑃𝑃(𝑖𝑖 ) ( )
𝑚𝑚-year 𝐵𝐵−𝐴𝐴−∑ 𝐶𝐶𝑡𝑡
forward rate, deferred 𝑡𝑡 years:
0 Forward Rates: (Effective Annual)
𝑖𝑖Duration
𝐷𝐷 = 𝐴𝐴+∑ , Initial balance
𝐷𝐷𝑡𝑡 andA, 𝑃𝑃𝑡𝑡 Ending
are the balance duration B, and Contribution 1+𝑖𝑖
price of components 𝐶𝐶𝑡𝑡 of Portfolio
𝐷𝐷1 𝑃𝑃1 +𝐷𝐷2 𝑃𝑃2 +⋯+𝐷𝐷𝑛𝑛 𝑃𝑃𝑛𝑛
𝐶𝐶𝑡𝑡of a Portfolio: First-Order forward Modified rate,𝐷𝐷(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃)
deferredPrice Approximation:𝑡𝑡 =years: 𝑃𝑃(𝑖𝑖0 ) − 𝑃𝑃(𝑖𝑖0 )(𝑖𝑖 − 𝑖𝑖0 )𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖0 )
𝑚𝑚-year 𝑃𝑃1 +𝑃𝑃2 +⋯+𝑃𝑃𝑛𝑛𝑃𝑃(𝑖𝑖) ≈
(1−𝑡𝑡) 𝑚𝑚
(1 + 𝑟𝑟𝑡𝑡 )𝑡𝑡 (1 + 𝑓𝑓[𝑡𝑡,𝑡𝑡+𝑚𝑚] ) = (1 + 𝑟𝑟𝑡𝑡+𝑚𝑚 )𝑡𝑡+𝑚𝑚 𝑚𝑚 INTEREST RATE SWAPS
(1 + 𝑟𝑟𝑡𝑡 )𝑡𝑡 (1 + 𝑓𝑓[𝑡𝑡,𝑡𝑡+𝑚𝑚] ) = (1 + 𝑟𝑟𝑡𝑡+𝑚𝑚 )𝑡𝑡+𝑚𝑚
) 0 𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖0 )
Time-Weighted Method: 𝑃𝑃(𝑖𝑖) ≈ 𝑃𝑃(𝑖𝑖0 )IMMUNIZATION
𝐷𝐷𝑚𝑚𝑚𝑚𝑚𝑚(𝑖𝑖01+𝑖𝑖
One-year
First-order forward
modified rate,price deferred 𝑡𝑡 years:
approximation: − 𝑃𝑃(𝑖𝑖0 )(𝑖𝑖 − 𝑖𝑖0 )𝐷𝐷First-Order 𝑚𝑚𝑚𝑚𝑚𝑚 (𝑖𝑖0 ) First-order
Macaulay Macaulay
Price price approximation:
Approximation: 1−𝑃𝑃𝑛𝑛 ≈ 𝑃𝑃(𝑖𝑖 𝑃𝑃(𝑖𝑖)
1+𝑖𝑖 ≈0)𝑃𝑃(𝑖𝑖 0 ) ( 1+𝑖𝑖 )
𝐵𝐵(1+𝑟𝑟 𝐵𝐵2𝑡𝑡+1 𝐵𝐵 Constant
One-year Notional
forward rate,Value: deferred n-year 𝑡𝑡 swap
years: rate 𝑅𝑅 =𝑃𝑃(𝑖𝑖) 0 ) ( Variable Notional Values: 𝑅𝑅 =
+ 𝑖𝑖 𝑇𝑇 =
1𝑓𝑓[𝑡𝑡,𝑡𝑡+1] 1
= 𝐵𝐵0 (1+𝑟𝑟 ∙ 𝑡𝑡+1 ) ∙ … ∙ 𝑃𝑃𝑡𝑡𝑛𝑛 , Balance 𝐵𝐵 before any contribution 𝐶𝐶 ∑ 𝑃𝑃𝑖𝑖 1+𝑖𝑖
𝑡𝑡 1 − 1 = − 21
𝐵𝐵1 +𝐶𝐶 𝐵𝐵𝑛𝑛−1 +𝐶𝐶 𝑡𝑡 𝑡𝑡
Redington Immunization:
𝑡𝑡 ) 𝑃𝑃𝑡𝑡+1 (i)𝑛𝑛−1
𝑑𝑑PV(Assets) = PV(Liabilities) 𝑑𝑑2 (i) 𝑃𝑃(1+𝑟𝑟
𝐴𝐴 = 𝑡𝑡+1 𝑃𝑃𝐿𝐿)𝑡𝑡+1 𝑃𝑃𝑡𝑡 (i) ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣𝑃𝑃𝑡𝑡𝑡𝑡−𝑃𝑃 =𝑡𝑡+𝑚𝑚∑ 𝐿𝐿𝑡𝑡 𝑣𝑣 𝑡𝑡 (
𝑓𝑓
t-year =
[𝑡𝑡,𝑡𝑡+1] deferred m-year − 1 swap= − 1 −𝑡𝑡
𝑃𝑃𝑡𝑡+1rate:(ii)
∑ 𝑡𝑡 2 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 2 𝑃𝑃 ∑ 𝑡𝑡(𝑡𝑡+1)𝐴𝐴 𝑣𝑣 𝑡𝑡+2 2 𝑃𝑃 𝐶𝐶 +𝐷𝐷 𝑅𝑅 ∑ = 𝑡𝑡 = ∑ 𝑡𝑡𝐿𝐿 𝑣𝑣 𝑡𝑡 (1
𝑃𝑃𝑡𝑡 = + 𝑟𝑟𝑡𝑡 ) 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] = (1+
Convexity: 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 = ∑ 𝑡𝑡 =(ii)𝑑𝑑𝛿𝛿Duration(Assets) 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚 = =∑ Duration(Liabilities) 𝑡𝑡
= 𝑑𝑑𝑖𝑖 = 𝑚𝑚𝑚𝑚𝑚𝑚 𝑚𝑚𝑚𝑚𝑚𝑚
(ii) 𝑃𝑃′𝐴𝐴(1+𝑟𝑟 = 𝑡𝑡𝑃𝑃′ )𝑡𝑡𝐿𝐿 𝑡𝑡𝐴𝐴
𝑃𝑃𝑡𝑡+1𝑡𝑡 𝑣𝑣+⋯+𝑃𝑃 𝑡𝑡+𝑚𝑚 𝑡𝑡
Price of a Stock - Dividend 𝐴𝐴𝑡𝑡 𝑣𝑣
(iii)Discount
𝑃𝑃
Convexity(Assets) Model: >𝐴𝐴𝑡𝑡𝑣𝑣Convexity(Liabilities)
𝑡𝑡 𝑃𝑃 (1+𝑖𝑖) 2
(iii) 𝑃𝑃"𝐴𝐴 > 𝑃𝑃"𝐿𝐿 (iii) ∑ 𝑡𝑡 2 𝐴𝐴𝑡𝑡 𝑣𝑣 𝑡𝑡 > ∑ 𝑡𝑡 2 𝐿𝐿𝑡𝑡 𝑣𝑣 𝑡𝑡 IMMUNIZATION
nd 𝐷𝐷
2𝑃𝑃 =Column , Level dividends
𝑖𝑖 nd Liability cash outflow and one after it.
Full Immunization:
𝑃𝑃 =
𝐷𝐷 (i) and (ii) as above, (iii) One Asset cash inflow before 2
, Dividends increasing at rate 𝑘𝑘% with first 𝐷𝐷 at time 1, 𝑘𝑘 IMMUNIZATION < 𝑖𝑖
each ColumnImmunization: (i) PV(Assets) DETERMINANTS
Redington = PV(Liabilities) OF INTEREST RATES (i) 𝑃𝑃𝐴𝐴 = 𝑃𝑃
Immunization
Inflation 𝑖𝑖−𝑘𝑘 Rate: Real rate of interest 𝑖𝑖 ′ , Inflation rate 𝑟𝑟 (ii) Duration(Assets) = Duration(Liabilities) (ii) 𝑃𝑃′𝐴𝐴 =
st
1Exact
+ 𝑖𝑖 =Matching(1 + 𝑖𝑖′)(1 or + 𝑟𝑟), Dedication: 𝑖𝑖 = 𝑖𝑖 ′ + Match 𝑟𝑟 + 𝑖𝑖both ′ 𝑟𝑟 the amount and the time of Assets 1 Column
Inflation and Liabilities
Rate: Real rate of interest (iii) Convexity(Assets)
𝑖𝑖 ′ , Inflation rate> 𝑟𝑟Convexity(Liabilities) (iii) 𝑃𝑃"𝐴𝐴 >
Spot
Redington Rates:Immunization: Effective annual yield rate on investment
(i) PV(Assets) = PV(Liabilities) for 𝑡𝑡 years, 𝑟𝑟𝑡𝑡 1U.S. + 𝑖𝑖 = (1 (i)
Treasury 𝑃𝑃𝐴𝐴 Bills:
+ 𝑖𝑖′)(1 =+ 𝑃𝑃𝐿𝐿𝑟𝑟), 𝑖𝑖 = 𝑖𝑖 ′ + 𝑟𝑟 + 𝑖𝑖 ′(i)
𝑡𝑡
𝑟𝑟 ∑ 𝐴𝐴𝑡𝑡 𝑣𝑣 = ∑ 𝐿𝐿𝑡𝑡 𝑣𝑣
𝑡𝑡

Price of a 𝑡𝑡-year zero-coupon Bond:

Duration: 𝑃𝑃𝑡𝑡 = (1 + 𝑟𝑟𝑡𝑡 )−𝑡𝑡 = Duration(Liabilities)Full Immunization:
(ii) Duration(Assets) (ii) 𝑃𝑃′ = 𝑛𝑛𝑃𝑃′ (i) and (ii) as above,(ii)(iii) ∑ One
𝑡𝑡𝐴𝐴 𝑣𝑣 360
𝑡𝑡Asset
= ∑ 𝐶𝐶 −
cash 𝑡𝑡𝑃𝑃inflow before each Liability ca
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃 = 𝐶𝐶 (1 − 𝐴𝐴 𝑑𝑑)
𝐿𝐿 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑑𝑑 =𝑡𝑡 ( ) ( 𝑡𝑡 𝑣𝑣 )
𝑡𝑡𝐿𝐿
(iii) Convexity(Assets) > Convexity(Liabilities)
INTEREST RATE SWAPS
Duration: (iii) 𝑃𝑃"𝐴𝐴 > 𝑃𝑃"𝐿𝐿 360 𝑛𝑛
(iii) ∑ 𝑡𝑡 𝐴𝐴𝑡𝑡 𝑣𝑣 > ∑ 𝑡𝑡 𝐿𝐿𝑡𝑡 𝑣𝑣 𝑡𝑡
2 𝑡𝑡 2𝐶𝐶
Forward Rates: (Effective Annual) Exact Matching or Dedication: Match both the amount and the time of Assets and Liabili
𝑚𝑚-year
Full
Constant forward
Immunization: Notional rate, Value:deferred
(i) and n-year(ii)𝑡𝑡as years:
swapabove, rate(iii) 𝑅𝑅 = One 1−𝑃𝑃𝑛𝑛
Asset cashVariable inflow before NotionalGovernment
each Liability
Values: of𝑅𝑅 Canada ∑ 𝑄𝑄 𝑓𝑓[𝑡𝑡−1,𝑡𝑡]
cash𝑡𝑡 outflow
= Treasury 𝑃𝑃𝑡𝑡
and Bills: one after it.
𝑚𝑚 ∑ 𝑃𝑃𝑖𝑖 𝐶𝐶 ∑ 𝑄𝑄𝑡𝑡 𝑃𝑃𝑡𝑡 365 𝐶𝐶 − 𝑃𝑃
(1 + 𝑟𝑟𝑡𝑡 )𝑡𝑡 (1 + 𝑓𝑓[𝑡𝑡,𝑡𝑡+𝑚𝑚] ) = (1 + 𝑟𝑟𝑡𝑡+𝑚𝑚 )𝑡𝑡+𝑚𝑚 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃 and = Liabilities (1+𝑟𝑟𝑡𝑡 )𝑡𝑡 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑖𝑖 = ( )( )
Exact
t-year deferred Matching m-year or Dedication: swap rate: 𝑅𝑅 Match=
𝑃𝑃both
𝑡𝑡 −𝑃𝑃𝑡𝑡+𝑚𝑚the amount and the time of Assets
𝑃𝑃𝑡𝑡 = (1 + 𝑟𝑟𝑡𝑡 )−𝑡𝑡 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] = 𝑛𝑛 − 1 =
𝑃𝑃𝑡𝑡−1
− 1 𝑛𝑛 INTEREST 𝑃𝑃 RATE SWAPS
𝑃𝑃𝑡𝑡+1 +⋯+𝑃𝑃𝑡𝑡+𝑚𝑚 (1 + (1+𝑟𝑟𝑡𝑡−1 𝑖𝑖))𝑡𝑡−1 𝑃𝑃𝑡𝑡
One-year forward rate, deferred 𝑡𝑡 years: 365
(1+𝑟𝑟𝑡𝑡+1 )𝑡𝑡+1 𝑃𝑃𝑡𝑡 1−𝑃𝑃𝑛𝑛
𝑓𝑓[𝑡𝑡,𝑡𝑡+1] = −1= −1 Default
ConstantRisk: 𝑥𝑥 amount
Notional received
Value: n-yearwith
swapno default
rate 𝑅𝑅 = Variable Notional Values:
Determinants of Interest Rates DETERMINANTS OF INTEREST
(1+𝑟𝑟𝑡𝑡 ) 𝑃𝑃𝑡𝑡+1 𝑡𝑡
RATES
(1 − 𝑞𝑞)𝑦𝑦 = 𝑥𝑥, 𝑦𝑦 amount received with a default
∑ 𝑃𝑃
rate 𝑞𝑞 𝑖𝑖
𝑃𝑃𝑡𝑡 −𝑃𝑃𝑡𝑡+𝑚𝑚
DETERMINANTS (1 OF
t-year INTEREST
deferred RATES
m-year swap rate: 𝑅𝑅 =
− 𝑞𝑞)𝑦𝑦 + 𝑞𝑞(𝑢𝑢𝑢𝑢) = 𝑥𝑥, with a partial recovery
𝑃𝑃 +⋯+𝑃𝑃rate 𝑢𝑢 𝑃𝑃𝑡𝑡 = (1 + 𝑟𝑟𝑡𝑡 )−𝑡𝑡 𝑓𝑓[𝑡𝑡−1,𝑡𝑡] =
st 𝑡𝑡+1 𝑡𝑡+𝑚𝑚
1nd Column
U.S. Treasury Bills: 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = 𝑃𝑃 = 𝐶𝐶 (1 − 𝑑𝑑)
𝑛𝑛
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = 𝑑𝑑 = ( ) ( )
360 𝐶𝐶−𝑃𝑃
2U.S.Column
Treasury Bills: 360 Components 𝑛𝑛 𝐶𝐶 of Interest Rate 𝑹𝑹:
𝑛𝑛 360 𝐶𝐶 −𝐶𝐶 𝑃𝑃 𝑟𝑟 rate without default risk, rate for risk compensation,
365 𝑠𝑠 𝐶𝐶−𝑃𝑃 𝑖𝑖 inflation rate
Government of Canada
𝐶𝐶 (1 −Real𝑑𝑑)
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃 = Rate: Treasury Bills:
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
′ 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑑𝑑 = ( = 𝑃𝑃 =
)( 𝑛𝑛 ) 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = 𝑖𝑖 = ( ) ( ) DETERMINANTS OF INTEREST RATES
Inflation 360 rate of interest 𝑖𝑖 , Inflation rate 𝑛𝑛 𝑟𝑟 (1+𝐶𝐶365𝑖𝑖) 𝑛𝑛 𝑃𝑃
1 + 𝑖𝑖 = (1 + 𝑖𝑖′)(1 + 𝑟𝑟), ′
𝑖𝑖 = 𝑖𝑖 + 𝑟𝑟 + 𝑖𝑖 𝑟𝑟 ′
Withst Default Risk but No Inflation:
Default
Government Risk:of Canada Treasury Bills: 1 Column
𝑅𝑅 = (1 + 𝑟𝑟)(1 + 𝑠𝑠) − 1 (effective) 𝑅𝑅 = 𝑟𝑟 + 𝑠𝑠 (continuous)
(1 − 𝑞𝑞)𝑦𝑦 = 𝑥𝑥, 𝑥𝑥𝐶𝐶 amount received with no default,365 𝑦𝑦 amount
𝐶𝐶 − 𝑃𝑃received with default, U.S. Treasury Bills:
𝑞𝑞 default rate
Duration:
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃 =+ 𝑞𝑞(𝑢𝑢𝑢𝑢)𝑛𝑛 = 𝑥𝑥, with a partial
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑖𝑖rate
= ( 𝑢𝑢 ) ( ) 𝑛𝑛 360 𝐶𝐶 − 𝑃𝑃
(1 − 𝑞𝑞)𝑦𝑦 recovery 𝑛𝑛 𝑃𝑃 With
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃Default
𝑃𝑃 = 𝐶𝐶 Risk
(1 − and Known 𝑑𝑑) Inflation:
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑑𝑑 = ( )( )
(1 + 𝑖𝑖)
365 𝑅𝑅 = (1 + 𝑟𝑟)(1 + 𝑠𝑠)(1 + 𝑖𝑖) − 1 (effective) 𝑅𝑅 = 𝑟𝑟 + 𝑠𝑠 + 𝑖𝑖𝑛𝑛 (continuous)
360 𝐶𝐶
Components of Interest Rate 𝑹𝑹: No Inflation but with Default Risk: 𝑅𝑅 = (1 + 𝑟𝑟)(1 + 𝑠𝑠) − 1, 𝑟𝑟 rate without default risk,
rate forRisk:
𝑠𝑠Default risk compensation
𝑥𝑥 amount received (Effective
with noRates) default 𝑅𝑅 = 𝑟𝑟 + 𝑠𝑠, with Continuous Government
With
Rates of Canada
Default Risk and UncertainTreasury Bills:
Inflation:
(1 − 𝑞𝑞)𝑦𝑦 = 𝑥𝑥, 𝑦𝑦 amount received with a default rate 𝑞𝑞 𝐶𝐶 , 𝑖𝑖 and 𝑖𝑖 continuous expected and 365 𝐶𝐶 − 𝑃𝑃 inflation rates
With Known Inflation and Default Risk:
(1 − 𝑞𝑞)𝑦𝑦 + 𝑞𝑞(𝑢𝑢𝑢𝑢) = 𝑥𝑥, with a partial recovery rate 𝑢𝑢 𝑅𝑅 = (1 + 𝑟𝑟)(1 + 𝑠𝑠)(1 + 𝑖𝑖) − 1, 𝑖𝑖 𝑅𝑅𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
= 𝑟𝑟 +𝑃𝑃 𝑠𝑠inflation
effective =+ 𝑖𝑖𝑒𝑒 + 𝑖𝑖𝑢𝑢rate
𝑛𝑛 𝑒𝑒 𝑅𝑅𝑢𝑢 = 𝑟𝑟 + 𝑠𝑠 + 𝑖𝑖, 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑖𝑖 = ( unexpected
with continuous ) ( rates )
(1 + 𝑖𝑖) 𝑛𝑛 𝑃𝑃
With Uncertain Inflation: 𝑅𝑅 = 𝑟𝑟 + 𝑠𝑠 + 𝑖𝑖𝑒𝑒 + 𝑖𝑖𝑢𝑢 , 𝑖𝑖𝑒𝑒 continuous expected inflation rate, 𝑖𝑖𝑢𝑢 continuous unexpected inflation rate 365
Components of Interest Rate 𝑹𝑹:
𝑟𝑟 rate without default risk, 𝑠𝑠 rate for risk compensation, 𝑖𝑖 inflation rate Default Risk: 𝑥𝑥 amount received with no default
(1 − 𝑞𝑞)𝑦𝑦 = 𝑥𝑥, 𝑦𝑦 amount received with a default rate 𝑞𝑞
With Default Risk but No Inflation: (1 − 𝑞𝑞)𝑦𝑦 + 𝑞𝑞(𝑢𝑢𝑢𝑢) = 𝑥𝑥, with a partial recovery rate 𝑢𝑢
𝑅𝑅 = (1 + 𝑟𝑟)(1 + 𝑠𝑠) − 1 (effective) www.ACTEXMadRiver.com
𝑅𝑅 = 𝑟𝑟 + 𝑠𝑠 (continuous)
Components of Interest Rate 𝑹𝑹:
www.StudyManuals.com
With Default Risk and Known Inflation: 𝑟𝑟 rate without default risk, 𝑠𝑠 rate for risk compensation, 𝑖𝑖 inflation rate