xy Time Value of Mone: dutors robe, Enrich & Empower READING TIME VALUE OF MONEY Ce eee ee et cena a Required rate | Required rate of return is the return that investors and savers require to get them ofreturn | to willingly lend their funds. Discount rate | It is the rate used for the purpose of compounding or discounting cash flows. Opportunity | Opportunity cost is the compensation for an opportunity forgone when current cost —_| consumption is chosen rather than saving (postponing consumption). ieee teeter ae B compensate investors for bearing distinct types of risk. This is the discount rate (or required rate) applicable to risk-free projects and instruments such as T-bills. There are two types of risk free rates viz. risk free real rate & risk free nominal rate. Risk free rate (R) Real R— This rate doesn’t contain inflation premium. Nominal R:~ This rate contains inflation premium. R; (Nominal) = R, (Real) + Inflation premium, ik Default risk premium — to cover up against defaults, Liquidity risk premium — to cover up against illiquidity. Premiums | Maturity risk premium — to cover up against risk due to longer maturity. Required : Required return = Ry Risk premiums return: ‘a m ‘eset | calculate and interpret the effective annual rate given the stated annual interest rate eee EAR = (1+4r/m)™ -1 ‘Where, r annual rate. m =n. of compounding periods in year. tim = periodic interest rate. Example: Calculate EAR of 12% p.a. compounded (i) semi-annually; (ii) quarterly; (iii) monthly.x Edutors CEAY Level solve, Enrich & Empower Sy ameomes Bra Miscellaneous learning outcomes on the practical portions of this readi FUTURE VALUE OF A SINGLE CASH FLOW FV = PV (14i) ‘Where, FV = future value. PV = present value. i periodic interest rate. fn —-=no. of periods. PRESENT VALUE OF A SINGLE CASH FLOW PV = FV/(1+i)" Where, FY = future value py = present value. i periodic interest rate. a = no. of periods. ANNUITIES: Ordinary Annuity ~ End of the year; use end mode. Calculate PMT Annuity Due — Beginning of the year; use beginning mode.je Value of Money PRESENT VALUE OF A PERPETUITY PVa=A/i Where, A = Annuity amount (PMT). i = periodic interest rate. DEALING WITH UNEQUAL CASH FLOWS Step 2: Insert all cash flows. Step 2: Perform functions thereafter. CONTINUOUS COMPOUNDING FV=PVxet PV = FV/ett Where,r = annual continuous rate. t = part of the year i.e. 1/365, ky dutors Brolve,Envieh & Empower