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##  A. Future Value, Present Value and Interest

Rates
 B. Understanding Risks, types of Risks and
measurements or Risk
 C. Bonds, Bond Prices and determination of
Interest Rates
 Future Value - Future Value (FV) is a formula
used in finance to calculate the value of a
cash flow at a later date than originally
received. This idea that an amount today is
worth a different amount than at a future
time is based on the time value of money.
 Formula = FV = PV(1+r)n
 Where:
 FV = Future Value
 PV = Principal Value
 r = Rate
 n = Time Period
 Example:
The future value of 1,000 compounded at a 10%
annual interest rate at the end of one year, two
years and five years are computed as follows:

## Year 1: FV= 1,000(1+.10)1= 1,100

Year2: FV= 1,000(1+.10)2= 1,210
Year 5: FV = 1,000(1+.10)5 = 1,610.51
 Present Value – is the current value of a
future amount of money

FV
Formula: PV = (1+r)n
Where: PV = Present Value
FV = Future Value
r = Rate
n = Time Period
 Example: Blueberry Company expects to
receive 1,100 one year from now. What is the
present value of this amount if the discount
rate is 10%?

1,100
PV = (1+.10)1 = 1,000
 Interest is the cost of using money overtime.

Simple Interest = I = P r t
 Compounded Interest
 Example:
An amount of \$1,500.00 is deposited in a bank
paying an annual interest rate of 4.3%,
compounded quarterly. What is the balance
after 6 years?
 Basic Risks:
Systematic Risk - Systematic risk influences a large
number of assets. A significant political event, for
example, could affect several of the assets in your
portfolio. It is virtually impossible to protect yourself
against this type of risk.
Unsystematic Risk - Unsystematic risk is sometimes
referred to as "specific risk". This kind of risk affects a very
small number of assets. An example is news that affects a
specific stock such as a sudden strike by employees.
Diversification is the only way to protect yourself from
unsystematic risk.
Credit or Default Risk - Credit risk is the risk that a company
or individual will be unable to pay the contractual interest or
principal on its debt obligations. This type of risk is of
particular concern to investors who hold bonds in their
portfolios. Government bonds, especially those issued by the
federal government, have the least amount of default risk
and the lowest returns, while corporate bonds tend to have
the highest amount of default risk but also higher interest
rates. Bonds with a lower chance of default are considered to
be investment grade, while bonds with higher chances are
considered to be junk bonds.
 Country Risk - Country risk refers to the risk that
a country won't be able to honor its financial
commitments. When a country defaults on its
obligations, this can harm the performance of all
other financial instruments in that country as
well as other countries it has relations with.
Country risk applies to stocks, bonds, mutual
funds, options and futures that are issued within
a particular country. This type of risk is most
often seen in emerging markets or countries
that have a severe deficit.
 Foreign-Exchange Risk - When investing in foreign countries you
must consider the fact that currency exchange rates can change
the price of the asset as well. Foreign-exchange risk applies to all
financial instruments that are in a currency other than your
domestic currency. As an example, if you are a resident of America
and invest in some Canadian stock in Canadian dollars, even if the
share value appreciates, you may lose money if the Canadian
dollar depreciates in relation to the American dollar.
 Interest Rate Risk - Interest rate risk is the risk that an
investment's value will change as a result of a change in interest
rates. This risk affects the value of bonds more directly than
Market.)
 Political Risk - Political risk represents the financial risk that a
country's government will suddenly change its policies. This is a
major reason why developing countries lack foreign investment.
 Market Risk - This is the most familiar of all risks. Also referred to
as volatility, market risk is the the day-to-day fluctuations in a
stock's price. Market risk applies mainly to stocks and options. As a
whole, stocks tend to perform well during a bull market and poorly
during a bear market - volatility is not so much a cause but an
effect of certain market forces. Volatility is a measure of risk
because it refers to the behavior, or "temperament", of your
investment rather than the reason for this behavior. Because
market movement is the reason why people can make money
from stocks, volatility is essential for returns, and the more
unstable the investment the more chance there is that it will
experience a dramatic change in either direction.
 Risk management is a crucial process used to
make investment decisions. The process
involves identifying the amount of risk
involved and either accepting or mitigating
the risk associated with an investment. Some
common measures of risk are standard
deviation, beta, value at risk (VaR) and
conditional value at risk.
 Standard deviation measures the dispersion of data
from its expected value. The standard deviation is
used in making an investment decision to measure
the amount of historical volatility, or risk, associated
with an investment relative to its annual rate of
return. It indicates how much the current return is
deviating from its expected historical normal returns.

##  For example, a stock that has a high standard

deviation experiences higher volatility, and therefore,
a higher level of risk is associated with the stock.
 Beta is another common measure of risk. Beta
measures the amount of systematic risk a security has
relative to the whole market. The market has a beta of
1, and it can be used to gauge the risk of a security. If a
security's beta is equal to 1, the security's price moves
in time step with the market.
 A security with a beta greater than 1 indicates that it is
more volatile than the market. Conversely, if a
security's beta is less than 1, it indicates that the
security is less volatile than the market. For example,
suppose a security's beta is 1.5. In theory, the security
is 50% more volatile than the market.
 A third common measure of risk used in risk
management is the value at risk. The VaR is a
statistical measure used to assess the level of
risk associated with a portfolio or company. The
VaR measures the maximum potential loss with
a degree of confidence for a specified period.
 For example, suppose a portfolio of investments
has a one-year 10% VaR of \$5 million. Therefore,
the portfolio has a 10% chance of losing more
than \$5 million over a one-year period.
 Conditional VaR is another risk measure used to assess
the tail risk of an investment. The conditional VaR assesses
the likelihood, with a certain degree of confidence, that
there will be a break in the VaR. This measure is used as an
extension to the VaR and seeks to assess what happens to
an investment beyond its maximum loss threshold. This
measure is more sensitive to events that happen in the tail
end of a distribution, also known as tail risk.
 For example, suppose a risk manager believes the average
loss on an investment is \$10 million for the worst 1% of
possible outcomes for a portfolio. Therefore, the
conditional VaR, or expected shortfall, is \$10 million for
the 1% tail.
 A bond is a fixed income investment in which an investor
loans money to an entity (typically corporate or
governmental) which borrows the funds for a defined
period of time at a variable or fixed interest rate. Bonds
are used by companies, municipalities, states and
sovereign governments to raise money and finance a
variety of projects and activities. Owners of bonds are
debtholders, or creditors, of the issuer.
 When companies or other entities need to raise money to
finance new projects, maintain ongoing operations, or
refinance existing debts, they may issue bonds directly to
investors instead of obtaining loans from a bank.