Question 2a: Explain the mechanism of calculating the present value of

cash flows. What is annuity due? How can you calculate the present and
future values of an annuity due? Illustrate
n sw er 2a:
!al cul atin g "resen t #alue o f !ash flow s:
Money has time value. For ex: Rs.1000 received today is not the same worth after a year (actually it is
less)
"rese n t va l u e o f cash fl ows : It indicates the value of expected worth at current value. (iscounts the
expected cash flows at appropriate discount rate (may !e 10"# $0" etc.#)
$iscount rate will %enerally !e e&ual to ' Inflation rate ( Re&d. rate of return ( ris) free premium rate
$eta i l s re % uired fo r ca l cula t ing "rese n t # a lu e o f cash f lo w s : *ash flows year wise# discount rate. +his
techni&ue is very useful for decision,ma)in%.
nnuity du e: -niform. *onstant. /&ual cash flows every year
"resent value of annuity &uture value of annuity
0orth of 1ump sum consideration today which
is %oin% to !e received tomorrow
2alue of fixed investment every year 3 worth
tomorrow. (i.e. corpus it %rows)
*o m pu t at i on:
4nnuity 5 6resent value annuity factor (624F)
624F is calculated as ' 1,71.(1(r) to the power
n8.
4nnuity 5 Future value annuity factor (F24F)
F24F is calculated as ' 7(1(r) to the power n8 , 1
I ll u s t ra ti o n :
Mr. 4 would li)e to receive Rs.1000., every
year for 10 years from now.
It is assumed discount rate 10"# the present
value annuity factor for 10 years 10" is 9.1::.
6resent value of annuity ' 1000 5 9.1:: '
Rs.91:;.,
Mr.< would li)e to %row a corpus !y investment
of Rs.10# 000 3 10 years from now.
Rate of interest =10"# the future value annuity
factor for 10 years 10" is 1.;>:
Future value of annuity ' 10000 5 1.;>:'
Rs.1;>?@.,
Question 2': ()he increase in the ris*+premium of all stoc*s, irrespective
of their 'eta is the same when ris* aversion increases( !omment
with practical examples
n sw er
2' :
+he securityAs !eta is a function of the correlation of the securityAs returns with the mar)et index
returns and the varia!ility of the securityAs returns relative to the varia!ility of the index returns.
In simple# !eta measures the sensitivity of the stoc) with reference to !road !ased mar)et
index.
&o r ins t a n ce : a !eta of 1.$ for a stoc) would indicate that this stoc) is $0" ris)ier than the
index B
similarly !eta of 0.> for a stoc) indicates 10" less ris)ier than the
index. Finally# a !eta of 1.0 means# stoc) is as ris)y as the stoc)
mar)et index.
+herefore# the %iven statement is false. /xpected ris),premium for stoc) i s ' eta time s the mar)et
ris) premium. For ex: let us assume !eta ' 1.$ times# mar)et ris) premium ' 10"# then expected ris)
premium
' 10" 5 1.$ times '
1$".