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A rupee today is more valuable than a rupee a year hence. Why? • Individuals prefer current consumption to future consumption. • Capital can be employed productively to generate positive returns. . a rupee today represents a greater real purchasing power than a rupee a year hence. • In an inflationary period.

.Time lines and Notation A time line shows the timing and the amount of each cash flow in a cash stream. • Period of time • Point of time Cash flow can be positive (cash inflow) or negative (cash outflow) Notations used: PV : Present Value FVn : Future value n years hence Ct : Cash flow occurring at the end of year t A : A stream of constant periodic cash flow over a given time r : Interest rate or discount rate g : Expected growth rate in cash flows n : Number of periods over which the cash flows occur.

Future value of a Single amount • The process of investing money as well as reinvesting the interest earned thereon is called Compounding. the investment grows as follows: FV = PV [ 1+ Number of years * Interest rate ] • Doubling Period: Rule of 72 Rule of 69 • Finding the growth rate . • The future value or compounded value of an investment after n years when the interest rate is r percent : FVn = PV(1+r)n • In case of Simple Interest.

is the inverse of compounding. PVn = Present value of a cash flow stream At = Cash flow occuring at the end of year t r = Discount rate n = Duration of the cash flow stream n .Present value of a Single amount • The process of discounting . PV = FVn [ 1 / (1+r)n ] • Present Value of an uneven cash flow stream: PVn = t=1 [At / (1+r)t ] ∑ Where. used for calculating the present value .

FVAn = FV of an annuity which has a duration of n periods A = Constant periodic flow r = interest rate per period n = duration of the annuity . Regular/Deferred annuity (end of the period) Annuity due (beginning of the period) Future value of an annuity • The future value of an annuity : FVAn = A [ (1+r)^n – 1] / r Where.Annuity • An annuity is a stream of constant cash flows occurring at regular intervals of time.

(1/1+r)^n} / r ] Annuities Due The cash flows of an annuity due occur one period earlier in comparison to the cash flows on an ordinary annuity. Annuity due value = Ordinary annuity value* (1+r) .Present value of an annuity • The present value of an annuity: PVAn = A [ {1.

P∞ = Present value of a perpetuity A= The constant annual payment ∞ PVIFAr ∞= ∑ [1/(1+r)t] =1/r t=1 .Present value of a Perpetuity • A perpetuity is an annuity of indefinite duration.∞ Where. • The present value of a perpetuity : P∞ = A * PVIFAr.

• Diversification is the key to effective risk management. .Risk and Return • Risk is the chance that the actual return differ from its expected return. • The riskiness of a financial asset is measured in terms of the riskiness of its cash flows.

Beginning price Beginning price Probability distributions: The probability for a particular outcome is simply the chance that the specified outcome will occur.Risk and Return of a Single Asset Rate of return: Annual income + Ending price . . The result of considering these outcomes and their probabilities together is a probability distribution.

E(R))² Where. Variance of returns • It is the difference between an expected and actual result. σ² = pi (Ri .Expected rate of return • It is the weighted average of all possible returns multiplied by their respective probabilities. • It is a measure of dispersion of a set of data points around their mean value. σ² = Variance Ri = Return for the ith possible outcome pi= The probability associated with the ith possible outcome E (R)= Expected return .

σ =(σ²)^1/2 Where. σ = Standard deviation .Standard deviation of returns • It is a statistic used as a measure of dispersion or variation in a distribution • It is equal to the square root of the arithmetic mean of the squares of the deviations from the arithmetic mean.

Risk and Return of a Portfolio Portfolio: A collection of investments all owned by the same individual or organization. These investments often include: Stocks (which are investments in individual businesses) Bonds (which are investments in debt that are designed to earn interest) Mutual funds (which are essentially pools of money from many investors that are invested by professionals or according to indices) .

E(Rp) = The expected return on portfolio wi= The proportion of portfolio invested in security i E(Ri)= The expected return on security i n .Expected return on a portfolio E(R p ) w iE(R i ) i1 Where.

Total risk= Unique risk + Market risk • Unique risk/Unsystematic risk/Diversifiable risk • Market risk/Systematic risk/Non-diversifiable risk .Measurement of Market risk • The market risk of a security reflects its sensitivity to market movements.

• Calculation of Beta Rjt= αj + βjRMt +ej Where. beta RMt = The retun on market portfolio in period t ej = The random error term βj= Cov(Rj.• The sensitivity of a security to market movements is called beta (β).RM) / σ2M Beta for market portfolio = 1 . Rjt = The return of security j in period t αj = The intercept term alpha βj = The regression coefficient .

Thank you .

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