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Excel Formulas for Financial Mathematics and Investment Analysis

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 Excel Formulas for
Financial Mathematics
and Investment Analysis

Peter Pflaumer

Unlock the Power of Excel in Financial Mathematics and

Investment Analysis! This handbook is not just about Excel
commands; it's a unique guide that pairs every Excel
formula with its underlying mathematical counterpart.
Learn financial principles, apply them using Excel, and
compare results side by side. Ideal for anyone seeking a
practical understanding of financial mathematics and
investment analysis. Excel Formulas for Financial
Mathematics and Investment Analysis € where theory meets
application.
 Excel Formulas for Financial Mathematics and
Investment Analysis
Peter Pflaumer

peter.pflaumer@tu-dortmund.de

Studien des Kompetenzzentrums für Unternehmensentwicklung und -Beratung

(KUBE e.V.), Kempten 2024.

The Competence Center for Business Development and Consulting, accessible at

www.kube-ev.de, operates as a registered association primarily dedicated to advancing,
implementing, and sharing business management methodologies and tools in both theoretical
and practical contexts. Prof. Dr. Peter Pflaumer served two tenures on the association's board
of directors: from 2000 to 2004 and subsequently from 2016 to 2020.
Contents

Introduction

1. Fundamentals of Financial Formulas

1.1 Excel Formula Separators and Regional Settings 5
1.2 Unifying Compound Interest and Annuity Calculations 5
1.3 Cash Flow Convention in Financial Calculations 5
1.4 Symbols of Mathematical Formulas 6

2. Annuity Calculation with Compound Interest and Periodic Payments

2.1 Difference Between Two Dates (DAYS360, YearFrac) 7
2.2 Future Value (FV) with Constant Interest Rates 9
2.3 Future Value (FVSCHEDULE) with Varying Interest Rates 13
2.4 Present Value (PV) 14
2.5 Net Present Value (NPV) and NPV Function 18
2.5.1 Net Present Value (NPV) 18
2.5.2 NPV Function 20
2.6 Present Value (XNPV) 25
2.7 Number of Periods (NPER) 26
2.8 Payment (PMT) for Annuities 29
2.9. Depreciation Methods (SLN, DDM, SYD, VDB) 32

3. Functions of an Amortization Schedule

3.1 Loan Amortization Schedule 36
3.2 Selected Functions with Examples 37
3.3 Calculating Prepayment Penalties for Loans 40

4. Price and Duration of Bonds and Other Securities

4.1 Price of a Bond (PRICE) 43
4.2 Average Security Maturity (DURATION and MDURATION) 45

5. Interest Rate Functions

5.1 Effective and Nominal Interest Rates (EFFECT and NOMINAL) 48
5.2 Interest (RATE) Function 50
5.3 Internal Rate of Return (IRR) 53
5.4 Modified Internal Rate of Return (MIRR) 55
5.5 Yield of a Fixed-Income Financial Security (YIELD) 58
5.6 Internal Rate of Return (XIRR) 60

2
Intoduction

The "Excel Formulas for Financial Mathematics and Investment Analysis" handbook
provides comprehensive insights into financial calculations using Excel. It covers various
topics, including compound interest, annuity calculations, amortization schedules, bond
pricing and duration, interest rate functions, and more. The handbook explores essential Excel
functions such as NPV, RATE, IRR, MIRR, YIELD, and XIRR, demonstrating their
applications in diverse financial scenarios.
It provides an overview of each Excel function, follows up with examples, and then
demonstrates how to solve those examples both using the Excel function and through
financial mathematical formulas. This structure is effective for readers who want to
understand both the practical application in Excel and the underlying mathematical concepts.

This format ensures a comprehensive understanding for readers, allowing them to see the
practical application in Excel alongside the theoretical foundations of financial mathematics.
It's a robust approach that caters to a diverse audience with varying levels of expertise in both
Excel and financial mathematics.
The combination of Excel functions and mathematical formulas provides a well-rounded
learning experience. Users not only learn how to utilize Excel for practical applications but
also gain insights into the underlying mathematical concepts. Moreover, the potential for
errors in Excel serves as a learning opportunity, allowing users to develop a deeper
understanding of the relationships between variables and the impact of different parameters
on the results.

The structure of the handbook is designed to facilitate effective learning. It begins by

providing an overview of essential Excel functions such as NPV, RATE, IRR, MIRR, YIELD,
and XIRR. Following this introduction, each Excel function is accompanied by real-world
examples, allowing readers to grasp the practical applications in financial scenarios. What
sets this handbook apart is its dual approach to problem-solving—readers not only learn to
apply these functions in Excel but also gain a deep understanding of the underlying
mathematical formulas.
This format ensures a comprehensive learning experience. Readers, irrespective of their
proficiency in Excel or financial mathematics, will find this handbook accessible and
informative. The step-by-step guidance through practical examples in Excel, coupled with the
exploration of financial mathematical formulas, caters to a diverse audience. Whether readers
seek practical application or a deeper understanding of the theoretical foundations, this
handbook provides a robust and effective learning resource.

The "Excel Formulas for Financial Mathematics and Investment Analysis" handbook is an
updated English version of the work by P. Pflaumer, titled Excel-Funktionen für
Finanzmathematik und Investitionsrechnung, published in Studien des Kompetenzzentrums
für Unternehmensentwicklung und -beratung e.V., Kempten, 20071.

The primary information on financial Excel functions for this handbook is obtained from the
official Microsoft Excel support, providing extensive documentation and resources on this
subject2.

1
https://www.researchgate.net/publication/372907651_Excel-
Funktionen_fur_Finanzmathematik_und_Investitionsrechnung
2
https://support.microsoft.com/en-au/office/financial-functions-reference-5658d81e-6035-4f24-89c1-
fbf124c2b1d8

3
The financial mathematical background draws from the textbooks by Ihrig & Pflaumer
(2009)3 and Pflaumer (2018)4.

ChatGPT assisted me in translating and editing the text. The cover picture has been generated
by AI.

Peter Pflaumer

January 5, 2024

3
H. Ihrig; P. Pflaumer (2009): Finanzmathematik, 11. Aufl., München.
https://www.degruyter.com/document/doi/10.1524/9783486599336/html
4
P. Pflaumer (2018): Grundwissen Investitionsrechnung, 4. Aufl., Kempten.
https://www.researchgate.net/publication/351587409

4
1. Fundamentals of Financial Formulas

1.1 Excel Formula Separators and Regional Settings

The use of semicolons (;) instead of commas (,) as separators in Excel formulas is related to
regional settings and language preferences. Different locales and versions of Excel may
default to different separators.
In many European countries, including Germany, the semicolon is commonly used as the list
separator in Excel formulas, while in English-speaking countries, the comma is more standard.
To adjust this setting in Excel:
Open Excel.
Go to "File" > "Options."
In the Excel Options dialog box, go to the "Advanced" tab.
Under the "Editing options" section, find the "Use system separators" checkbox.
Check or uncheck the box based on your preference.
Click "OK" to apply the changes.

1.2 Unifying Compound Interest and Annuity Calculations

In financial mathematics textbooks, a distinction is often made between compound interest

and annuity calculations. However, when working with Excel functions, there is no need to
separate these two concepts as the same financial mathematics Excel functions are utilized.
In Excel functions, both annuity and compound interest calculations can be performed
seamlessly using the same set of functions. For annuity calculations, the annuity amount is
entered, whereas for compound interest calculations, the annuity is either omitted or the
number 0 is entered as the amount of the annuity. This unified approach simplifies the
application of financial mathematics in Excel, providing flexibility in handling both scenarios
within a consistent framework.

1.3 Cash Flow Convention in Financial Calculations

In financial calculations, the convention for cash flows is often to use a positive sign for
money you receive (inflows) and a negative sign for money you pay or invest (outflows).
This convention helps maintain consistency in the formulas and is widely adopted in financial
mathematics. So, the negative sign reflects the initial investment or outflow of funds. If you
were receiving a payment, it would be positive.
However, it's important to note that in verbal interpretation, where the annuity of a loan is, for
example, $-1,000, we would say the annuity is $1,000. The sign is dependent on the context
in this publication."

5
1.4 Symbols of Mathematical Formulas

Symbols

K0 Present value or inital principal in compounding (PV)

Kn Future value at time n in compounding (FV)

R0 Present value of an annuity (PV)

Rn Future value of an annuity at time n (FV)
C0 Net present value (NPV)
S Loan amount
r or A Payment per period (PMT)
ct Cash flow at time t

n Number of compounding periods (NPER)

p Interest rate; often as a decimal, i.e., p/100 or i=p/100) (RATE)

p
q  1 Interest rate factor (1+i)
100
1
Discount factor
q
qn 1
Future value factor (in arrears; payments made at the end of a period)
q 1

1 qn 1
Present value factor (in advance; payments at the beginning of a period)
qn q 1
q 1
qn  n Annuity factor (inverse of the future value factor)
q 1

D Duration

6
2. Annuity Calculation with Compound Interest and Periodic Payments
2.1 Difference Between Two Dates (DAYS360, YearFrac)

DAYS360

This Excel function calculates the number of days between two dates based on a year of 360
days. It provides flexibility in choosing between the American and European methods of
counting days.

Syntax: =DAYS360(start_date, end_date, method)

Parameters:
start_date: The starting date of the period.
end_date: The ending date of the period.
method: A Boolean value indicating whether the American (FALSE) or European (TRUE)
method should be used.
Note: The method parameter is optional. If omitted, the function assumes FALSE (American
method).

YearFrac
Converts the number of whole days between the start date and end date into fractions of
years.

Syntax: =YEARFRAC(start_date, end_date, basis, [basis])

Parameters:
start_date: The starting date of the period.
end_date: The ending date of the period.
Basis: Optional. The type of day count basis to use
0 or omitted US (NASD) 30/360
1 Actual/actual
2 Actual/360
3 Actual/365
4 European 30/360

Remarks:

Days360:
The method is a Boolean value indicating whether the American or European method should
be used in the calculation.
TRUE: European method: Any start or end date falling on the 31st of a month is changed to
the 30th of the same month.
Note: From February 28th to March 30th, 32 interest days are calculated!

FALSE or not specified: US method: If the start date is the 31st of a month, this date is
changed to the 30th of the same month. If the end date is the 31st of a month and the start

7
date is a date before the 30th of a month, the end date is changed to the 1st of the following
month. In all other cases, the end date is changed to the 30th of the same month.

Examples

Example 1: How many days are there between the following date ranges when considering
the "European method" and the “American method”?

Start Date End Date Days/TRUE Days/FALSE

1/1/2024 1/31/2024 29 30
1/1/2024 1/30/2024 29 29
2/20/2024 3/3/2024 13 13
3/30/2024 4/30/2024 30 30
5/31/2024 6/7/2024 7 7
1/1/2024 12/31/2024 359 360
2/28/2024 3/30/2024 32 32

For example:
=DAYS360("01/01/2024", "01/31/2024", TRUE) = 29
=DAYS360("01/01/2024", "01/31/2024", FALSE) = 30

Example 2: Calculate the difference in years between April 20, 2024, and April 30, 2023,
using the YEARFRAC function with various day count conventions.

Excel Commands:

Parameter 0: Actual/Actual (default)

=YEARFRAC("04/30/2023", "04/20/2024", 0)
Result: 1.0014 years

Parameter 1: 30/360
=YEARFRAC("04/30/2023", "04/20/2024", 1)
Result: 1.0028 years

Parameter 2: Actual/360
=YEARFRAC("04/30/2023", "04/20/2024", 2)
Result: 1.0028 years

Parameter 3: Actual/365 or
=YEARFRAC("04/30/2023", "04/20/2024", 3)
Result: 1.0014 years

Parameter 4: European 30/360

=YEARFRAC("04/30/2023", "04/20/2024", 4)
Result: 1.0028 years

8
2.2. Future Value: FV with Constant Interest Rates

FV

This Excel commands calculates the future value of an investment based on periodic, constant
payments with compound interest.

Syntax: =FV(rate, nper, pmt, [pv], [type])

Parameters:
rate: The interest rate per period.
nper: The total number of payment periods.
pmt: The payment made each period; it remains constant throughout. In interest
compounding scenarios where there are no regular payments, the pmt parameter is
set to 0.
pv: The present value, or the initial investment or loan amount. If omitted, the function
assumes pv=0.
type: . 0 if payments are due at the end of the period, 1 if they are due at the beginning of
the period. If omitted, the function assumes 0, meaning payments are due at the end of
the period.

rate, nper, and pmt are required parameters.

[pv] and [type] are optional parameters. If you don't provide a value for these, Excel will
assume default values (usually 0).

Examples:

Example 1: At the end of each year, $1000 is deposited into a savings account, which earns a
3% interest. What is the total amount saved, including compound interest, at the end of the
10th year?

Excel Command: =FV(3%, 10, -1000, 0, 0) or =FV(3%, 10, -1000)

qn 1 1.0310  1
Formula: Rn  r  1000   11463.88
q 1 0.03

Result: $11,463.88

Example 2: At the beginning of each year, $1000 is deposited into a savings account, which
earns a 3% interest. What is the total amount saved, including compound interest, at the end
of the 10th year?

Excel Command: =FV(3%, 10, -1000, 0, 1)

qn 1 1.0310  1
Formula: Rn  r  q  1000 1.03   11807.80
q 1 0.03

Result: $11,807.80
9
Example 3: Someone invests $50,000 at the beginning of the year 2024 with a 4% compound
interest. Additionally, $5,000 is deposited annually, at the end of each year, for 12 years.
What is the balance after 12 years?

Excel Command: =FV(4%, 12, -5000, -50000, 0)

Formula:
qn 1 1.0412  1
R n  K 0  q n  r  50000 1.0412  5000   155180.64
q 1 0.04

Result: $155,180.64

Example 4: Someone invests $50,000 at the beginning of the year 2024 with a 4% compound
interest. Starting at the end of each year, $5,000 is withdrawn annually for 12 years. What is
the balance after 12 years?

Excel Command: =FV(4%, 12, 5000, -50000)

qn 1 1.0412  1
Formula: R n  K 0  q n  r   50000 1.0412  5000   4922.58
q 1 0.04

Result: $4,922.58

Example 5: An individual invests €20,000 initially at an annual compound interest rate of 6%.
Determine the total amount at the conclusion of 5 years under the following compounding
scenarios:
a) Annual compounding b) Semi-annual compounding c) Monthly compounding d)
Continuous compounding

Excel Commands:
a) =FV(6%, 5,0, -20000, 0) or =FV(6%, 5, 0, -20000)
b) =FV(6%/2, 5*2, 0, -20000, 0) or =FV(6%/2, 5*2, 0, -20000)
c) =FV(6%/12, 5*12, 0, -20000, 0) or =FV(6%/12, 5*12, 0, -20000)
d) For continuous compounding, there isn't a direct Excel function. The formula is
=20000*EXP(6%*5)

Comment: Excel does not offer a dedicated function for explicit interest compounding.
Therefore, the formulas provided below can be used to manually calculate compound interest.
In certain situations, performing manual calculations with the compounding formula may
prove to be quicker and more straightforward.

Formulas: K n  K 0  q n ; K 0  20, 000 a) n=5;q=1.06; b) n=10; q=1.03; c) n=60; q=1.005

d) K n  K 0  e p /100n ; n=5; p=6

10
Results:

a) Total amount with annual compounding after 5 years: €26,764.51

b) Total amount with semi-annual compounding after 5 years: € 26,878.33
c) Total amount with monthly compounding after 5 years: € 26,977.00
d) Total amount with continuous compounding after 5 years: € 26,997.18

Example 6: A savings contract is concluded. At the beginning of each month, €50 will be
saved for 7 years. The interest rate is 0.5% per month. What is the future value of the
annuity?

Excel Command: =FV(0.5%, 7*12, -50,0,1) or =FV(0.5%, 7*12, -50,,1)

qn 1 1.00584  1
Formula: Rn  r  q   50 1.005   5229.71 (n=7*12)
q 1 0.005
Result: € 5,229,71

Example 7:
a) At the end of each quarter, $100 is deposited into a savings account for a period of exactly
1 year, resulting in a total of 4 payments. The interest rate is 8% per year, and simple interest
is calculated. What is the balance after 1 year?

Excel Command: =A1*(C1+B1*(C1-1)/2),

where:
A1 is the constant payment per quarter (100),
B1 is the interest rate per year (8%) ,
C1 is the total number of quarters (4).
 p m  1 
Formula: (Equivalent annuity rate after 1 year) re  r   m    , r=100; m=4; p=8
 100 2 
Result: $412

b) At the beginning of each quarter, $100 is deposited into a savings account for a period of
exactly 1 year, resulting in a total of 4 payments. The interest rate is 8% per year, and simple
interest is calculated. What is the saldo after 1 year?

Excel Command: =A1*(C1+B1*(C1+1)/2),

where:
A1 is the constant payment per quarter (100),
B1 is the interest rate per year (8%),
C1 is the total number of quarters (4 ).

 p  m  1 
Formula: (Equivalent annuity rate after 1 year) re  r   m    , r=100; m=4; p=8
 100 2 
Result: $420

11
c) At the end of each quarter, $100 is deposited into a savings account for a period of exactly
1 year, resulting in a total of 4 payments. The interest rate is 8% per year, quarterly
compounding. What is the saldo after 1 year?

Excel Command: =FV(B1 / C1, C1, -A1),

where:
A1 is the constant payment per quarter,
B1 is the interest rate per year,
C1 is the total number of quarters (4 in this case).
qn 1 1.024  1
Formula: Rn  r   100   412.16
q 1 0.02
Result: $412.16

12
2.3 Future Value (FVSCHEDULE) with Varying Interest Rates

FVSCHEDULE
Returns the future value of an initial principal after applying a series of compound interest
rates.

Syntax: = FVSCHEDULE(principal, schedule)

Principal: Required. The present value.

Schedule: Required. An array of interest rates to apply.

Example: A bond with a maturity of 7 years has the following variable annual interest rates:
1st year: 2.50%, 2nd year: 2.75%, 3rd year: 3.25%, 4th year: 3.75%, 5th year: 4.25%, 6th
year: 4.75%, 7th year: 5.25%.
The investment amount is €5,000. What is the redemption value?

Excel Command =FVSCHEDULE(5000,{2.50%, 2.75%, 3.25%, 3.75%, 4.25%, 4.75%,

5.25%})

Note:
In Excel, you can use the FVSCHEDULE function with an array of interest rates to calculate the future value
under variable interest rates. The array {2.50%, 2.75%, 3.25%, 3.75%, 4.25%, 4.75%, 5.25%} represents the
interest rates for each year, and the function calculates the future value for a 7-year period with an initial
investment of €5,000.

Assuming your interest rates are in cells A1 to G1 and the initial investment is in cell B2, you
can use the following formula:

Excel Command: =FVSCHEDULE(B2,A1:G1)

It is often more straightforward and quicker to use the simplified numerical calculation using
the formula shown below.

Formula:
K n  K 0  q1  q2  ....qn  5000·1.025·1.0275·1.0325·1.0375·1.0425·1.0475·1.0525  6483.45

Result: €6,483.45

13
2.4 Present Value (PV)

PV

Returns the present value of n regular, equal payments, including a payment at the end of the
term. The present value is the total amount that a series of future payments is worth at the
current time. The present value is obtained by discounting the future value (FV). (PV =
Present Value).

Syntax: =PV(Interest; Nper; Pmt; Fv; Type)

Parameters:
Interest: The interest rate per period.
Nper: The total number of payment periods.
Pmt: The payment made each period; it remains constant throughout. In scenarios with no
regular payments, the Pmt parameter is set to 0.
Fv: The future value, or the end balance that you want to attain after the last payment. If
omitted, the function assumes Fv=0.
Type: 0 if payments are due at the end of the period, 1 if they are due at the beginning of the
period. If omitted, the function assumes 0, meaning payments are due at the end of the period.
Interest, Nper, and Pmt are required parameters. Fv and Type are optional parameters. If you
don't provide a value for these, Excel will assume default values (usually 0).

Examples

Example 1: At the end of each year, $1,000 will be received for 5 years, and the interest rate
is 4%. What is the present value of these future payments?

Excel Command: =PV(4%, 5, -1000, 0, 0) or =PV(4%, 5, -1000)

r qn 1 1000 1.045  1
Formula: R0  n     4451.82
q q 1 1.045 0.04

Result: $4,451.82

Example 2: At the beginning of each year, $1,000 will be received for 5 years, and the
interest rate is 4%. What is the present value of these future payments?

Excel Command: =PV(4%, 5, -1000, 0, 1)

r qn 1 1000 1.045  1
Formula: R0  n 1
    4629.90
q q 1 1.044 0.04

Result: $4,629.00

Example 3: An individual wants to have $10,000 at the end of 3 years. If the annual interest
rate is 6%, how much should be invested today?

14
Excel Command: =PV(6%, 3, 0, -10000, 0)

Kn 10000
Formula: K0    8396.19
qn 1.063

Result: $8,396.19

Example 4: An individual wants to have $10,000 at the beginning of each year for the next 3
years. If the annual interest rate is 6%, how much should be invested today?

Excel Command: =PV(6%, 3, -10000, 0 ,1)

r qn 1 10000 1.063  1
Formula: R0  n 1     28333.93
q q 1 1.062 0.06
Result: $28,333.93

Example 5: An investor intends to purchase an apartment building costing 1 million euros. He

anticipates annual net rental income of €70,000. After 20 years, he expects a selling price of
€1.8 million. What is the maximum price (present value) he should pay at an interest rate of
8%?

Excel Command: =PV(8%, 20, -70000, -1800000, 0)

 K n r q n  1 1800000 70000 1.0820  1

Formula: R0  n  n      1073457.09
q q q 1 1.0820 1.0820 0.08

Result: The maximum price (present value) the investor should pay at an 8% interest rate is
€1,073,457.09. Since the purchase price of 1 million euros is less than the present value, it
should be purchased, all else being equal.

Example 6: An investor intends to purchase an apartment building costing 1 million euros. He

anticipates annual net rental income of 60,000 euros for the first ten years, which will then
increase to 80,000 euros. After 20 years, he expects a selling price of 1.8 million euros. What
is the maximum price (present value) he should pay with an 8% interest rate? We assume that
the rental income occur at the end of each year.

Excel Command:
=PV(8%, 10, -60000, 0, 0) + (PV(8%, 10, -80000, -1800000, 0) / (1.08^10))

The formula calculates the present value of the expected cash flows from the investment,
considering net rental income for the first ten years and the present value of rental income for
the second ten years, including the expected future sales proceeds.

PV(8%, 10, -60000, 0, 0): This part calculates the present value of the net rental income of
€60,000 per year for the first ten years.

PV(8%, 10, -80000, -1800000, 0) / (1.08^10): This part calculates the present value of the net
rental income of €80,000 per year for the second ten years, including the future sales proceeds
of €1.8 million after 20 years. The division by (1.08^10) discounts these future cash flows
back to their present value.

15
Summing these two present values provides the maximum price (present value) that the
investor should be willing to pay for the apartment building, considering the given
assumptions and an 8% interest rate.

 60000 1.0810  1 1  1800000 80000 1.0810  1 

Formula: R0       1037436.94
1.0810 0.08 1.0810  1.0810 1.0810 0.08 

Result: The maximum price (present value) he should pay with an 8% interest rate is
€1,037,436.94.

Example 7: An individual has to make five payments of €100,000 each as the purchase price
for a house. The first payment is due immediately, while the remaining payments occur at
yearly intervals. Determine the amount required to settle the entire debt immediately with a
5% interest rate.

Excel Command: =PV(5%,5,-100000,0,1)

r qn 1 100000 1.055  1
Formula: R0  n 1     454595.05
q q 1 1.054 0.05

Result: The amount required for immediate debt settlement at a 5% interest rate is
€454,595.05.

Example 8: After precisely 3 years, an annual annuity of €20,000 is paid five times. Calculate
the present value of the annuity with a 6% interest rate.

Excel Command: =PV(6%,5,-20000,0,1)/1.06^3 or =PV(6%,3,0,-PV(6%,5,-20000,0,1))

Comment: The formula uses the PV function nested within another PV function. The inner
PV calculates the present value of the annuity with a 6% interest rate over 5 periods. The
result is then used as the cash flow for the outer PV function, which calculates the present
value over 3 periods. This nested structure is a powerful feature in Excel, allowing for the
composition of complex financial calculations within a single formula.

1  r qn 1  1  20000 1.065  1 
Formula: R0    n 1        74979.78
qm q q 1  1.063  1.064 0.06 

Result: €74,979.78

Example 9: A saver deposits €500 into his savings account at the beginning of each month
for 10 years, compounded monthly at a rate of 0.375%. Determine the amount he should
deposit immediately to achieve the same balance at the end with the same term and interest.

Excel Command: =PV(0.375%, 12 * 10, -500, 0, 1)

r qn 1 500 1.00375120  1
Formula: R0  n 1     48425.58
q q 1 1.00375119 0.00375

Result: €48,425.58
16
Example 10: Determine the amount that must be invested at a 4% annual interest rate for:
a) yearly interest payments
b) quarterly interest payments
So that it becomes €10,000 after 10 years.

Excel Command (a): =PV(4%, 10, 0, -10000, 0)

Kn 10000
Formula (a): K0    6755.64
qn 1.0410

Excel Command (b): =PV(4%/4, 10*4, 0, -10000, 0)

Kn 10000
Formula (b): K 0    6716.53
qn 1.0140

Result: a) €6,755.64 b) €6,716.53

17
2.5 Net Present Value (NPV) and NPV Function

2.5.1 Net Present Value (NPV)

NPV
NPV delivers the present value of a series of periodic cash flows at regular intervals,
occurring at the end of each period, and these cash flows can vary in amount. The present
value is the total amount that a series of future payments is worth at the present time.

Syntax: =NPV(rate, value1, value2, ...)

Parameters:
rate: The discount rate or interest rate per period.
value1, value2, ...: A series of cash flows representing income (positive values) and expenses
(negative values). These should occur at regular intervals.

Net Present Value (NPV) in Excel:

The Net Present Value (NPV) in Excel is a powerful financial tool used to evaluate the
profitability of an investment by calculating the present value of expected cash flows. It takes
into account the time value of money, helping users determine the current worth of future
income and expenses. The NPV function is commonly used in capital budgeting and
investment analysis.

Usage:
Enter the discount rate in percentage form as the first argument.
List the expected cash flows in sequential order, excluding the initial investment if it occurs at
the beginning of the first period. If the initial investment occurs one period before the date of
the first cash flow, include it in the values argument.

Interpretation:
A positive NPV indicates that the investment is expected to generate profit, and the higher the
NPV, the more attractive the investment.
A negative NPV suggests that the investment may not meet the desired rate of return.

Note: The NPV command assumes that cash flows occur at regular intervals. Adjustments
may be needed for irregular cash flow patterns using the XNPV function.

The NPV investment begins one period before the date of the value1 cash flow and ends with
the last cash flow in the list. The NPV calculation is based on future cash flows. If your first
cash flow occurs at the beginning of the first period, the first value must be added to the NPV
result, not included in the values arguments. For more information, see the examples below.

Example 1: An initial investment of $100,000 is made at time t=1, followed by cash inflows
of $30,000, $40,000, $50,000, and $60,000 in subsequent years. The NPV function calculates
the present value of these cash flows at an 8% discount rate.

Excel Command: =NPV(8%, -100000, 30000, 40000, 50000, 60000)

18
 5
ci 100000 30000 40000 50000 60000
Formula: C0         42467.35
t 1 qt 1.08 1.082 1.083 1.084 1.085

Result: NPV = $42,467.35 > 0; indicating that the investment is viable.

Example 2: An investor is faced with the decision of whether to proceed with an investment
(purchase of a tour bus) with the following (estimated) cash flow series: -660,000 124,600
149,000 173,400 503,400; the last cash flow includes the sales proceeds of the tour bus. The
initial investment occurs at time 0. The discount rate is 10%. Calculate the Net Present Value
(NPV) and Future Value (FV).

Excel Command: =NPV(10%, -660000, 124600, 149000, 173400, 503400)*1.1

or = -660000+NPV(10%, 124600, 149000, 173400, 503400)

Due to the discrepancy in the assumption of when the investment occurs (Excel assumes it
starts at time 1), the NPV result is multiplied by 1.1 to adjust for the difference in time
periods, aligning with the assumption that the investment occurs at time t=0.

Formula:

4 4
ci ci 124600 149000 173400 503400
C0   t
  I 0   t
 660000      50520.18
t 0 q t 0 q 1.1 1.12 1.13 1.14

Result: €50,520.18 > 0, indicating that the investment is profitable.

Note: The future value of the initial investment cash flow c0   I 0 ( I 0  0 : initial investment
outlay) is calculated as =FV(10%,4,0,-660000), yielding €966,306.00.
The future value of the investment series is calculated as =(FV(10%, 4, 0, NPV(10%,
124600, 149000, 173400, 503400)*1.1)), yielding €1,040,272.60.

The difference between these values is €73,966.60, representing the capital appreciation at
€73,966.60
time t=4. The discounted value,  €50,520.18 , is the net present value at time
1.14
t=0: =(NBW(10%, 124600, 149000, 173400, 503400))*1.1^4 = €1,040,272.60.

Regarding the use of the Future Value (FV) of the Investment, it's true that NPV is more
commonly used in capital budgeting and investment analysis. NPV directly considers the time
value of money and provides a clear measure of the profitability of an investment. It takes
into account the initial investment and the present value of future cash flows.
While the difference between FV of Investment Cash Flow and FV of Investment is a useful
concept for understanding capital appreciation, it may not be as widely used or recognized in
standard financial analysis as NPV. The NPV metric is often preferred because it represents
the net gain or loss at the present time, considering the cost of capital.
One notable advantage of NPV becomes apparent when comparing investment objects with
different different number of years. NPV allows for a straightforward comparison between
projects of varying lifespans, providing a comprehensive measure of their relative
profitability. This flexibility is a key strength of NPV in decision-making scenarios involving
multiple investment options with different time horizons.

19
However, the approach of highlighting the difference in Future Values as a clear and easy-to-
understand concept for users is valuable. Different investors may find various metrics more
intuitive, and providing multiple perspectives can enhance comprehension.

2.5.2 NPV Function

The Net Present Value (NPV) function, in the context of investment and finance, is a
mathematical expression that relates the NPV value to varying interest rates. The NPV
function aids in analyzing the impact of different interest rates on the present value of cash
flows over time, assisting in decision-making processes related to investments.
As a crucial tool in capital budgeting, the NPV function is dependent on the discount rate. It
assesses the profitability of an investment by considering the present value of expected future
cash flows, discounted at a specified rate. This rate, commonly known as the discount rate or
cost of capital, plays a crucial role in determining the NPV. The NPV function provides
insights into the viability of an investment, indicating at which discount rates the project
remains profitable (NPV > 0). Furthermore, when subjected to sensitivity analysis with
varying discount rates, the NPV function helps measure the risk sensitivity of an investment,
contributing valuable information to the decision-making process in capital budgeting.

Here's how risk sensitivity is related to the NPV function:

Discount Rate Impact: The NPV is calculated using a discount rate, which represents the cost
of capital or the minimum required rate of return. As the discount rate changes, the NPV of
future cash flows also changes. A higher discount rate generally leads to a lower NPV, while
a lower discount rate leads to a higher NPV.

Risk Assessment: By varying the discount rate, you can observe how sensitive the NPV is to
changes in the cost of capital. A project that remains profitable (positive NPV) across a range
of discount rates is considered less sensitive to changes in the cost of capital and, therefore,
less risky. On the other hand, a project with a narrow range of discount rates resulting in
positive NPV may be more sensitive and riskier.

Threshold Analysis: You can identify the discount rate at which the NPV becomes zero
(break-even point). This rate is often referred to as the Internal Rate of Return (IRR).
Understanding this threshold provides insights into the project's sensitivity to variations in the
cost of capital and helps assess the risk associated with the investment.

In summary, the NPV function, when used in sensitivity analysis with varying discount rates,
helps measure the risk sensitivity of an investment. Projects with more stable and positive
NPVs across a range of discount rates are generally considered less risky, while those with
higher sensitivity to changes in discount rates may be perceived as riskier.

Construction of the NPV Function

The NPV function for the tour bus investment (Example 2)

Construction: Column A contains the "Interest" rates (A2 to A18). Column C contains the
"Cash Flow" values (C2 to C6). Column B is where you want to calculate the "NPV" values.

20
Here are the steps:
In cell B2 (under "NPV"), enter the following formula:
=IF(A2="", "", NPV($A2, $C$3:$C$6) + $C$2)
Alternatively,
=IF(A2="", "",NPV(A2,C$2:$C$6)*(1+A2))

This formula checks if there's an interest rate in column A (A2 to A18). If there is, it
calculates the NPV using the specified interest rate and the cash flows in cells B2 to B6,
adding the negative cash flow at time 0. If there's no interest rate specified, it leaves the cell
blank.

Click on the lower right corner of cell C2 (the fill handle).

Drag the fill handle down to cover the entire "NPV" column (C2 to C18).
This action will automatically fill in the NPV values for each corresponding interest rate,
based on the specified cash flows.

The presented table illustrates the impact of varying interest rates on the Net Present Value
(NPV) and associated cash flows. The interest rates are listed in column A, corresponding
NPV values in column B, and the respective cash flows in column C. This table serves to
demonstrate how fluctuations in interest rates influence both NPV and cash flow outcomes.

A B C
1 Interest NPV Cash Flow
2 0% 290,400 -660,000
3 1% 261,488 124,600
4 2% 233,833 149,000
5 3% 207,368 173,400
6 4% 182,027 503,400
7 5% 157,752
8 6% 134,487
9 7% 112,178
10 8% 90,778
11 9% 70,240
12 10% 50,520
13 11% 31,578
14 12% 13,374
15 13% -4,126
16 14% -20,958
17 15% -37,153
18 16% -52,742

Figure 1 displays the graphical representation of the NPV function.

21
 350000

300000

250000

200000

150000

100000

50000

0
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%
-50000

-100000

Figure 1: NPV function of the tour bus investment (Example 2)

The Net Present Value (NPV) function assesses the profitability of a tour bus investment at
various interest rates, with an initial investment outflow of €660,000. The desired discount
rate for this investment is 10%.

Here's an interpretation of the NPV function:

At 0% Interest (No Discount): The NPV is €290,400. In this scenario, the NPV is essentially
the sum of the inflows minus the initial investment outflow. This positive NPV of €290,400 at
no discount suggests a promising outlook for the tour bus investment when considering future
cash flows without discounting. At a discount rate of 0%, the NPV is the sum of cash inflows
and outflows without any discounting.

As Interest Rates Increase: With increasing interest rates, the NPV function decrease. Higher
interest rates result in a more significant discounting effect on future cash flows, impacting
the present value of the investment.

At the Hurdle Rate of 10%: At this desired discount rate, the NPV is €50,520.18. The
positive NPV at the hurdle rate indicates that the investment is financially favorable. The
present value of future cash flows at a 10% discount rate exceeds the initial investment,
meeting the company's minimum required rate of return.

Negative NPV: The NPV turns negative at an interest rate of 13% and becomes more
pronounced at 16%. This implies that, at these interest rates, the present value of future cash
flows is insufficient to cover the initial investment. In the context of a tour bus investment,
this could signal a diminishing attractiveness or potential unprofitability, especially at higher
discount rates.

In general, the NPV function is a decreasing function dependent on the discount rate,
especially in scenarios involving regular investments or regular cash flow series. However,
it's important to note that this typical behavior may vary. Take, for instance, Example 3 (refer
to Durand, 19745), where the NPV function does not strictly follow the decreasing trend. This

5
Durand, D.: Payout Period, Time Spread and Duration. Journal of Bank Res., Spring 1974, 20-34.

22
anomaly occurs in situations involving irregular investments or irregular cash flow series.
Such investments, characterized by deviating from the typical patterns or structures, are often
referred to as unconventional, non-conventional or irregular investments.

Example 3: The objective is to enhance the yield of an ore mine. To achieve this, an
additional investment of $180,000 in machinery is made at time t = 0. Consequently, annual
surplus cash flows increase by $100,000 from t = 1 to t = 5. Due to the amplified yield, the
ore reserves are depleted after 5 years, leading to annual surplus cash flows from t = 6 to t =
10 being $100,000 less than they would have been without the extra investment. The mine
remains inactive from t = 11 to t = 19, with zero surplus cash flows during this period. At
time t = 20, the property is sold, assuming a selling price $200,000 higher than initially
estimated due to the additional investment of $180,000. How should the investment be
assessed?

Solution: The cash flow series of the investment is as follows:

year cash flow

0 -180
1 100
2 100
3 100
4 100
5 100
6 -100
7 -100
8 -100
9 -100
10 -100
11 0
12 0
13 0
14 0
15 0
16 0
17 0
18 0
19 0
20 200

The net present value (NPV) function intersects the abscissa at 1.86%, 14.35%, and 29.02%
(see Figure 2)

The investment proves profitable at discount rates lower than 1.86% or between 14.35% and
29.02%; in these cases, the net present value is positive.
The pattern of the net present value function can be explained by dividing the surplus cash
flows into two components: the ongoing cash flows and the residual payment. At low
discount rates (p < 1.86%), the investment is advantageous because the present value of the
residual value exceeds the investment outlay, while the present value of ongoing cash flows is
zero. As the interest rate increases, the residual value loses significance, resulting in a
negative net present value (1.86 < p < 14.35). If the interest rate exceeds 14.35%, the present
value of ongoing payments increases significantly, leading to a positive net present value
again, as equal amounts of positive and negative surplus cash flows occur. If the interest rate

23
exceeds 29.02%, the preceding positive payments also diminish in significance, and the
investment payment becomes substantial enough for the net present value to become negative
again.

25.00

20.00

15.00

10.00

5.00

0.00
0% 5% 10% 15% 20% 25% 30% 35% 40%
-5.00

-10.00

-15.00

-20.00

Figure 2: NPV function of an unconvential investment (Example 3)

Note: While Excel's Solver tool can be used to find solutions for specific NPV targets, finding
multiple solutions may be more straightforward with dedicated mathematical software. In this
study, the statistical software R was employed for the analysis.

24
2.6 Present Value (XNPV)

XNPV
XNPV calculates the net present value of a series of cash flows that may occur at irregular
intervals. It considers the actual dates associated with each cash flow, providing a more
accurate assessment of the time value of money.

Syntax: =XNPV(rate, values, dates)

Parameters:
rate: The discount rate or cost of capital per period.
values: An array or range of cash flows representing income (positive values) and expenses
(negative values). These cash flows can occur at irregular intervals.
dates: An array or range of dates corresponding to the cash flows. These dates should be in
chronological order.

XNPV is especially useful when dealing with cash flows that do not follow a regular periodic
schedule. It allows for a more precise evaluation of the net present value by considering the
actual timing of cash inflows and outflows.

Example: Suppose you are considering an investment project with the following irregular
cash flows:
Initial investment of $18,000 on January 1, 2023.
Positive cash inflow of $20,000 on June 30, 2023.
Negative cash outflow of $10,000 on December 31, 2023.
Positive cash inflow of $15,000 on March 15, 2024.
The discount rate for this investment is 8%.

Excel Command: =XNPV(8%, B2:B5, A2:A5),

assuming the cash flows are listed in cells B2 to B5, and the corresponding dates are in cells
A2 to A5. This command calculates the net present value with an interest rate of 8%.

c1 c2 c3
Formula: C0  c0   
q t1 q t2 q t3

date days years

1/1/2023
6/30/2023 180 0.4932
12/31/2023 364 0.9973
3/15/2024 439 1.2027
Calculated with YEARFRAC Option 3

20000 10000 15000

C0  18000     5667.81
q 0.4932 q 0.9973 q1.2027

Result: $5667.81

25
2.7 Number of Periods (NPER)

Nper

This Excel function calculates the number of payment periods required to reach a future value
based on periodic, constant payments with compound interest.

Syntax: =NPER(rate, pmt, pv, [fv], [type])

Parameters:
rate: The interest rate per period.
pmt: The payment made each period; it remains constant throughout. In scenarios with no
regular payments, set pmt to 0.
pv: The present value, or the initial investment or loan amount. If omitted, the function
assumes pv=0.
[fv]: The future value or desired amount. If omitted, the function assumes fv=0.
[type]: 0 if payments are due at the end of the period, 1 if they are due at the beginning of the
period. If omitted, the function assumes 0 (payments are due at the end of the period).
Note: rate, pmt, and pv are required parameters. [fv] and [type] are optional parameters.

I. NPER with Compound Interest Calculation

Example 1: How long must €10,000 be invested to yield an end capital of €25,000 at an
annual interest rate of 7%?

Excel Command: =NPER(7%, 0, -10000, 25000)

K   25000 
ln  n  ln  
 K0   10000 
Formula: n   13.54
ln q ln1.07

Result: 13.54 years

II. NPER with Given Annuity Present Value

Example 2: A lottery winner has won €500,000. If they invest it at 6%, how long can they
live off their winnings if they withdraw €50,000 at the a) end b) beginning of each year?

Excel Command (a): =NPER(6%, -50000, 500000)

   
 1   1 
ln   ln  
R 500000
 1  0   q  1   1  0.06 
Formula (a): n   r    50000   15.73
ln q ln1.06

Result (a): 15.73 years

26
Excel Command (b): =NPER(6%, -50000, 500000, , 1)

   
 1   
ln   1
ln 
 1  R0  q  1  50000 0.06 
  1   
 r q   50000 1.06   14.33
Formula (b): n  
ln q ln1.06

Result (b): 14.33 years

III. NPER with Given Future Value

Example 3: Someone wants to save €61,533 to buy a luxury car. How long does it take if they
save €10,000 annually at the beginning of each year at an interest rate of 7%?

Excel Command: =NPER(7%, -10000, 0, 61533,1)

 R   61533 
ln  n  (q  1)  1 ln   0.07  1
r q    10000 1.07
Formula: n  5
ln q ln1.07
R 
ln n  (q  1)  1
 r 
Note: (at the end of a year) n 
ln q

Result: 5 years

IV. NPER with Combined Interest and Annuity Payments

Example 4: Someone invests €1 million with compound interest at 6%. They deposit €50,000
annually in arrears (at the end of a year). After how many full years is the account balance
first more than €2,000,000?

Excel Command: =NPER(6%, -50000, -1000000, 2000000)

 R  q  1  r   2000000  0.06  50000 

ln  n  ln  
 K 0  q  1  r   1000000  0.06  50000 
Formula: n   7.47
ln q ln1.06

Result: 7.47 years (Since the payments occur at the end of a year, the result must be rounded
up to 8 years; the balance after 8 years is: 2,088,721).

V. NPER with Combined Interest and Withdrawals

Example 5: Someone invests €1 million with compound interest at 6%. They withdraw
€60,000 annually in advance. After how many full years is the account balance first below
€500,000?

Excel Command: =NPER(6%, 60000, -1000000, 500000, 1)

27
  R  q  1  r  q   500000  0.06  60000 1.06 
ln  n  ln  
K 0  q  1  r  q  1000000  0.06  60000 1.06 
Formula: n     38.33
ln q ln1.06

Result: 38.33 years; must be rounded up 39 years; balance after 38 years: 510,745; balance
after 39 years: 477,790.

Note: Withdrawal 'r' at the end of the year must follow the formula r   q  1  K 0 , and at

the beginning, it must adhere to the formula r 

q  1
 K 0 to obtain a finite running time.
q
Otherwise, in Excel, you will receive an error report; conditions must be met for accurate
calculations (K0 = capital at time 0; q = discount factor).

28
2.8 Payment (PMT) for Annuities

PMT
This function in Excel is used to calculate the periodic payment for an annuity based on
constant payments and a constant interest rate.

Syntax: =PMT(rate, nper, pv, [fv], [type])

Parameters:
rate: The interest rate per period.
nper: The total number of payment periods.
pv: The present value, or the total amount that a series of future payments is worth now.
[fv]: Optional. The future value, or a cash balance you want to attain after the last payment is
made. If omitted, it is assumed to be 0.
[type]: Optional. The timing of the payment: 0 for the end of the period, and 1 for the
beginning of the period. If omitted, it is assumed to be 0.

The rate, nper, and pv are required parameters.

The [fv] and [type] are optional parameters. If not provided, Excel assumes [fv] is 0 and
[type] is 0.

IPMT (Interest Payment) calculates the interest portion of a loan payment for a specific
period, while PPMT (Principal Payment) calculates the principal portion of the same loan
payment for a given period (see also chapter 3.1)

Examples

I. Payments with given Present Value

Example 1: A matured life insurance policy of €100,000 is not to be paid out immediately
but as an annual arrears annuity. What annuity can be expected with a term of 10 years and an
interest rate of 6%? How high would a monthly advance annuity be?

Excel Commands:

=RMZ(6%, 10, -100000)

=RMZ(6%/12, 12*10, -100000)

q 1 0.06
Formulas: r  R0  q n  100000 1.0610  13586.80
qn 1 1.0610  1
0.005
 100000 1.005120  1110.21
1.000510  1
Results:
13,586.80 (yearly)
1,110.21 (monthly)

29
Example 2: A loan of €40,000 is subject to 7.93% interest and is to be repaid through equal
annuities over a 5-year term.
a) Calculate yearly annuities.
b) Calculate monthly annuities with monthly compounding.

Excel Commands:
a) Annuity (Yearly): =PMT(7.93%, 5, -40000)
b) Annuity (Monthly): =PMT(7.93%/12, 5*12, -40000)

Formulas:
q 1 0.0793
a) r  R0  q n  40000 1.07935  9999.78
q 1
n
1.07935  1

0.0793
60
q 1  0.0793  12
b) r  R0  q n n  40000   1    809.72
q 1  12   0.0793 60
1   1
 12 

Results: a) approximately €10,000 b) €809.72

Example 3: (Mortgage Loan with Quarterly Interest) A mortgage loan of €100,000 has a term
of 25 years. Interest is compounded quarterly at 2%. What are the monthly expenses for this
loan?

Excel Command: =PMT(2%, 25*4, 100000)

q 1 0.02
Formula: r  R0  q n  100000 1.02100  2320.27
q 1
n
1.02100  1

Result: €2,320,27

II. Annuity with Given Future Value

Example 4: Someone wants to save €200,000 in 20 years. What are the annual savings with
a) arrears b) advance payments, assuming an interest rate of 5%?

Excel Command: =PMT(5%, 20, 0, -200000) =PMT(5%, 20, 0, 200000, 1)

q 1 0.05
Formulas: a) r  Rn   200000   6048.52
q 1
n
1.0520  1

Rn q  1 20000 0.05
b) r   n    5760.49
q q 1 1.05 1.0520  1

Results: a) €6,048.52 b) € 5,760.49

30
III. Combined Interest and Annuity Payments

Example 5: An initial amount of €1 million earns a 6% annual interest rate. How much must
be saved annually in arrears at a 6% interest rate to achieve an account balance of €2 million
after 10 years?

Excel Command: =PMT(6%, 10, -1000000, 2000000)

Formula:
q 1 0.06
 
 r  R n  K 0  q n  n
q 1
   2000000  1000000 1.0610  
1.0610  1
  15867.96

Result: Negative cash flow of €15,867.96 (savings)

31
2.9 Depreciation Methods (SLN, DDM, SYD, VDB)

SLN, DDM, SYD, VDB

Straight-Line Depreciation:
Syntax: =SLN(cost, salvage, life)
Declining Balance (Double Declining Method) Depreciation:
Syntax: =DDB(cost, salvage, life, period, [factor])
Factor Optional. The rate at which the balance declines. If factor is omitted, it is assumed to be 2 (the double-
declining balance method).
SYD (Sum-of-Years-Digits) Depreciation:
Syntax: =SYD(cost, salvage, life, per)
VDB (Variable Declining Balance) Depreciation:
Syntax: =VDB(cost, salvage, life, start_period, end_period, [factor], [no_switch])
If “no_switch” is set to TRUE, Excel will not switch to the straight-line depreciation method even if the
calculated depreciation amount is greater than that of the geometric depreciation.

Remarks:

Straight-Line Depreciation:
This method allocates an equal amount of depreciation expense each year over the useful life
of an asset. It's simple and results in a linear reduction in the asset's value.

Declining Balance (Double Declining Method) Depreciation:

This method applies a fixed percentage (often double the straight-line rate) to the remaining
book value of an asset. It results in higher depreciation expense in the early years, reflecting a
faster reduction in value.

Sum-of-Years-Digits (SYD) Depreciation:

SYD depreciation is based on a formula that takes the sum of the digits of the asset's useful
life. It allocates a higher proportion of depreciation to the earlier years, reflecting a faster
consumption of value.

Variable Declining Balance (VDB) Depreciation:

VDB is an extension of the declining balance method, allowing for a changing percentage of
depreciation. It's useful when the rate of depreciation changes during the asset's useful life.

Each method has its advantages and is suitable for different scenarios. Straight-line is
straightforward and easy to understand, while declining balance methods reflect the idea that
assets often lose more value in the earlier years of use. SYD offers a compromise between the
straight-line and declining balance approaches. VDB adds flexibility by accommodating
changing depreciation rates. The choice of method depends on factors such as accounting
standards, tax regulations, and the nature of the asset's use.

Examples

Example 1: =SLN(10000, 0, 5) calculates straight-line depreciation for an asset with a cost of

$10,000, no salvage value, and a useful life of 5 years.

32
Result: $2,000

B0  Bn 10000  0
Formula: D   2000
n 5

Example 2: =DDB(10000, 1000, 5, 3) calculates declining balance depreciation for an asset

with a cost of $10,000, salvage value of $1,000, and a useful life of 5 years for the 3rd year.

Result: $ 1,440

Remarks:

Depreciation Schedule:
Accumulated
Year Depreciation D. Book Value
1 4,000 4,000 6,000
2 2,400 6,400 3,600
3 1,440 7,840 2,160
4 864 8,704 1,296
5 296 9000 1000

p
Formula: Ak  Bk 1  k  1, 2, ...n (if the salvage value is zero)
100
e.g.: A3  B2  0.4  3600  0.4  1440

The geometric depreciation formula with the double declining balance (DDB) method provides a robust
approach for calculating depreciation when no salvage value is factored in. However, when a salvage value is
considered, a departure from the geometric depreciation model becomes necessary. In such instances,
adjustments are introduced, especially in the final years of the asset's useful life. The depreciation for the last
year or last few years is calculated as the difference between the remaining book value and the salvage value. In
Example 2, the depreciation in the last year is calculated as 1296−1000=296. This example illustrates the
adjustment needed to ensure a more accurate reflection of the asset's depreciation, taking into account the impact
of salvage value considerations.

Mathematical Background Depreciation Calculation

Initialization:
The DDB method initiates by setting the initial depreciation rate as double the straight-line
depreciation rate.
Depreciation Calculation:
Each period's depreciation D(k) follows a geometric series.
Mathematically, it's expressed as: D  k   BookV  k  1  DDB Rate ,
where BookV(k−1) represents the book value at the end of the previous period, and
DDB Rate is a fixed percentage.
Limitation:
A noteworthy constraint of the DDB method is its inability to depreciate the asset's value to
precisely zero. This can only be accomplished by switching to the linear depreciation method
when the geometric depreciation is smaller than the linear one, as demonstrated in Example 5.

Example 3: =SYD(10000, 0, 5, 3) calculates sum-of-years-digits depreciation for an asset

with a cost of $10,000, no salvage value, and a useful life of 5 years
for the third year.

33
Result: $2,000
2  B0  Bn  2 10000  0 
Formula: Dk   n  k  1   5  3  1  2000
n  n  1 56

Example 4: =VDB(10000, 1000, 5, start_period, end_period, 2, TRUE) calculates variable

declining balance depreciation for an asset with a cost of $10,000, a salvage value of $1,000,
a factor of 2 (which means double the straight-line depreciation), and a useful life of 5 years
across various periods.

Results: (see also example2)

Start End Explanation Result

0 1 period 1 4000
0 2 Periods 1 and 2 6400
1 3 Periods2 and 3 3840
2 4 period 3 and 4 2304
3 4 period 4 864
2 5 periods 3,4,5 2600
0 5 all periods 9000
0 3 periods 1,2,3 7840

Example 5: Consider an asset with a cost of $10,000, no salvage value, and a useful life of 5
years. To create the depreciation schedule, use the double declining balance method, with a
switch to linear depreciation if the linear method results in a greater depreciation amount than
the geometric method.

Solution:
One possibilty is using the VDB function and setting the no-switch option to FALSE
In Column A, enter the beginning periods (0, 1, 2, 3, 4).
In Column B, enter the corresponding end periods (1, 2, 3, 4, 5).
In Column C, use the following formula for each cell to calculate the depreciation:
=VDB(10000, 0, 5, A1, B1, 2, FALSE)
Drag this formula down for all rows in Column C.
In Column D, you can calculate the accumulated depreciation using the following formula:
=SUM($C$1:C1)
Drag this formula down for all rows in Column D.
In Column E, calculate the book value using the following formula:
=10000 - D1
Drag this formula down for all rows in Column E.
Now, the table will look like this:

A B C D E
1 0 1 4000 4000 6000
2 1 2 2400 6400 3600
3 2 3 1440 7840 2160
4 3 4 1080 (864) 8920 1080
5 4 5 1080 10000 0

In period 4, a switch is made from geometric (864) to linear depreciation (1080).

34
Example 6: A car with an acquisition value of €50,000 is to be depreciated using the double
declining balance method for 6 years, with a degressive rate of 30%, and switching to
straight-line depreciation until reaching a residual value of €0.

Results: =VDB(50000, 0, 6, A1, B1, 1.8, FALSE)

Depreciation schedule
A B C D E
1 0 1 15000 15000 35000
2 1 2 10500 25500 24500
3 2 3 7350 32850 17150
4 3 4 5716.67 38566.67 11433.33
5 4 5 5716.67 44283.33 5716.67
6 5 6 5716.67 50000 0

Column A: Beginning Period

Column B: Corresponding End Period
Column C: Depreciation for Each Period (using VDB function)
Column D: Accumulated Depreciation
Column E: Book Value

Explanation:
Similar to example 5, we use the VDB function:
=VDB(50000, 0, 6, A1, B1, k, FALSE)
where k=2 in this case. However, we need to find a new k adjusted to a depreciation rate of 30%.
Given that k=2 implies multiplying the linear depreciation rate (in our case, (50000/6)/50000=1/6) by 2,
resulting in k=0.33333.
The desired depreciation rate is 0.3. To find the adjusted k, we multiply 2 by 0.30/0.33330, yielding 1.8.
Therefore, we use the function:
=VDB(50000, 0, 6, A1, B1, 1.8, FALSE)
to create our depreciation schedule.

35
3. Functions of an Amortization Schedule
3.1 Loan Amortization Schedule

In this section, we delve into the functions of an amortization schedule - a crucial tool in
understanding the dynamics of loan repayment. Using the example of a $100,000 loan with a
2% quarterly interest rate and a quarterly repayment schedule over a 5-year term, we explore
how the amortization schedule is constructed and its key components.

Example: Loan $100,000; Interest 2% Quarterly; Repayment Quarterly; Term 5 Years

Construction Method:
The first step involves determining the fixed quarterly payment, commonly referred to as the
"quarterly payment," using the PMT function:
PMT: =RMZ(2%,20,−100,000)=$6,115.
Subsequently, the interest for each period is calculated by applying the quarterly interest rate
to the beginning balance. This interest amount is then subtracted from the quarterly payment
to obtain the principal portion. The principal is then deducted from the beginning balance to
derive the ending balance for each quarter.
This method is efficiently performed in Excel by utilizing the drag-down feature, which
allows for the extension of calculations across the entire schedule.

Amortization Table
Quarter Beginning Balance Payment per Period Interest per Period Principal Ending balance
1 100000.00 6115.67 2000.00 4115.67 95884.33
2 95884.33 6115.67 1917.69 4197.99 91686.34
3 91686.34 6115.67 1833.73 4281.94 87404.40
4 87404.40 6115.67 1748.09 4367.58 83036.81
5 83036.81 6115.67 1660.74 4454.94 78581.88
6 78581.88 6115.67 1571.64 4544.03 74037.84
7 74037.84 6115.67 1480.76 4634.91 69402.93
8 69402.93 6115.67 1388.06 4727.61 64675.32
9 64675.32 6115.67 1293.51 4822.17 59853.15
10 59853.15 6115.67 1197.06 4918.61 54934.54
11 54934.54 6115.67 1098.69 5016.98 49917.56
12 49917.56 6115.67 998.35 5117.32 44800.24
13 44800.24 6115.67 896.00 5219.67 39580.57
14 39580.57 6115.67 791.61 5324.06 34256.51
15 34256.51 6115.67 685.13 5430.54 28825.97
16 28825.97 6115.67 576.52 5539.15 23286.82
17 23286.82 6115.67 465.74 5649.94 17636.88
18 17636.88 6115.67 352.74 5762.93 11873.95
19 11873.95 6115.67 237.48 5878.19 5995.76
20 5995.76 6115.67 119.92 5995.76 0.00
Sum 122313.44 22313.44 100000

36
Explanation:
Beginning Balance: The outstanding loan amount at the beginning of each quarter.
Payment per Period: The fixed quarterly payment made by the borrower.
Interest per Period: The interest component of the payment, calculated as the beginning
balance multiplied by the quarterly interest rate.
Principal: The portion of the payment that goes toward reducing the loan balance.
Ending Balance: The remaining loan balance after deducting the principal portion of the
payment.

The sum of all annuities in an amortization schedule is often referred to as the "Total
Payments" or "Total Repayments." In this case, the sum of all annuities, which is $122,313.44,
could be called the "Total Payments."
Similarly, the sum of all interest payments is commonly referred to as the "Total Interest
Paid" or simply "Total Interest." In this case, the sum of all interest payments, which is
$22,313.44, could be called the "Total Interest Paid."
So, in summary:
$122,313.44 is the "Total Payments" or "Total Repayments."
$22,313.44 is the "Total Interest Paid" or "Total Interest."

This equation represents the relationship between the principal amount borrowed and the total
interest paid, resulting in the total payments made over the life of the loan:
Principal+Total Interest Paid=Total Payments.

This detailed amortization schedule provides a comprehensive view of how each payment
contributes to the reduction of the loan balance over the specified term. It is a powerful tool
for borrowers and lenders alike in managing and understanding the dynamics of loan
repayment.

3.2 Selected Functions with Examples

The results obtained from the selected functions in Section 3.2, including Regular Payment,
Principal Repayment, Cumulative Principal Repayment, Interest Payment, Cumulative
Interest Payment, and Ending Balance, can be directly compared with the corresponding cells
in the amortization plan presented in the previous section, offering a comprehensive analysis
of the loan repayment dynamics. These functions prove particularly useful when a detailed
computation of the entire schedule is not required, providing key insights into specific aspects
of the loan repayment process."

1. Regular Payment (PMT)

=PMT(interest_rate, periods, loan_amount)
Returns the regular payment (annuity) for a loan with a specified interest rate, number of
periods, and loan amount.
Example:
=PMT(0.02, 20, -100000)
Returns the regular payment for a loan with a 2% quarterly interest rate, 20 quarterly
payments, and a loan amount of $100,000.
Example Output: $6,115.67

37
2. Principal Repayment (PPMT)
=PPMT(interest_rate, current_period, periods, loan_amount)
Returns the principal repayment for a specific period in a loan with a specified interest rate,
number of periods, and loan amount.
Example:
=PPMT(0.02, 1, 20, -100000)
Returns the principal repayment for the first quarter of a loan with a 2% quarterly interest rate,
20 quarterly payments, and a loan amount of $100,000.
Example Output: $4,115.67

3. Cumulative Principal Repayment (CUMPRINC)

=CUMPRINC(interest_rate, periods, loan_amount, start_period, end_period)
Calculates the cumulative principal repayment for a loan with a specified interest rate,
number of periods, and loan amount between two specified periods.
Example:
=-CUMPRINC(0.02, 20, 100000, 1, 20)
Calculates the cumulative principal repayment for the entire loan term with a 2% quarterly
interest rate and a loan amount of $100,000.
Example Output: $100,000.00

4. Interest Payment (IPMT)

=IPMT(interest_rate, current_period, periods, loan_amount)
Returns the interest payment for a specific period in a loan with a specified interest rate,
number of periods, and loan amount.
Example:
=IPMT(0.02, 1, 20, -100000)
Returns the interest payment for the first quarter of a loan with a 2% quarterly interest rate, 20
quarterly payments, and a loan amount of $100,000.
Example Output: $2,000.00

5. Cumulative Interest Payment (CUMIPMT)

=CUMIPMT(interest_rate, periods, loan_amount, start_period, end_period)
Calculates the cumulative interest payment for a loan with a specified interest rate, number of
periods, and loan amount between two specified periods.
Example:
=-CUMIPMT(0.02, 20, -100000, 1, 20,0)
Calculates the cumulative interest payment for the entire loan term with a 2% quarterly
interest rate and a loan amount of $100,000.
Example Output: $22,313.44

6. Ending Balance in Period m

Ending Balance=Loan Amount+Cumulative Principal Repayment
Calculates the ending balance of a loan in period m by adding the loan amount to the
cumulative principal repayment up to period m.
Example: Ending Balance =100,000+CUMPRINC(0.02,20,100,000,1,7,0)
Calculates the ending balance in quarter 7 with a 2% quarterly interest rate and a loan amount
of $100,000.
Example Output: $69,402.93

38
Remarks:

interest: The constant interest rate per period.

periods: The total number of payment periods.
loan_amount: The loan amount.
future_value: The future value, or a cash balance you want to attain after the last payment is
made. (Optional)
type: The timing of the payment, 0 or 1, indicating the end or the beginning of the period,
respectively. (Optional)

Formulas:

q 1
A  r  S  qn  Annuity (S=loan)
qn 1
0.02
A  r  100000 1.0220   6115.67
1.0220  1
q n  q k 1
Rk 1  S  Ending Balance after k-1 Periods
qn 1
1.0220  1.027
R7  100000   69402.93
1.0220  1
A k 1
Tk  n
 q  T1  q k 1 Principal Repayment in Period k (PPMT)
q
p 2
with T1  A  Z1  A  S  T1  6115.67  100000   4115.67
100 100

Z k  A  Tk Interest Payment in Period k (IPMT)

Z1  6115.67  4115.67  2000
log A  log T1
n Amortization Period =NPER(2%,-6115.67,100000) =20
log q
ln 6115.67  ln 4115.67
n  20
ln1.02
Aall  n  A Total Payments
Aall  20  6115.67  122313.44

We aim to conclude this section by calculating the annuity of a loan, displaying not the final
value of 0 but a remaining financing balance.

Example: What is the annuity of an installment loan of €100,000 with annual repayment,
which is subject to an interest rate of 6% and has a term of 5 years, assuming a remaining
financing balance of €10,000 at the end of the term?

39
Excel Command: =PMT(6%,5,-100000,10000)
q 1 0.06
Formula:  
r   R n  K 0  q n  n
q 1
  10000  100000 1.065  
1.065  1
 21965.68

Result: €21,965.68

3.3 Calculating Prepayment Penalties for Loans (Using Financial Mathematical

Methods)

A prepayment penalty is a charge imposed by a lender when a borrower settles a loan before
its scheduled maturity date. This fee serves as a mechanism for lenders to recover a portion of
the interest they would have earned had the borrower adhered to the original payment
schedule. The terms and conditions related to prepayment penalties can exhibit significant
variation and are typically delineated in the loan agreement.
Prepayment penalties are frequently associated with specific loan types, notably mortgages.
Borrowers may opt for early repayment for various reasons, including refinancing at a lower
interest rate or selling a property. The imposition of a prepayment penalty acts as a deterrent
against early repayment and safeguards the lender's anticipated interest income.
It is crucial for borrowers to meticulously review loan agreements to ascertain the existence
of a prepayment penalty and, if applicable, to comprehend the specific terms associated with
it. In certain instances, borrowers may engage in negotiations with lenders to mitigate or
eliminate prepayment penalties as part of their loan terms. Additionally, regulations
governing prepayment penalties may vary depending on jurisdiction.

Example: Consider a scenario where a fixed-rate annuity loan of €300,000, featuring monthly
amortization and monthly compounding, was acquired at the close of 2013 from a bank at a
9% interest rate. The loan's term, or interest rate fixation period, spanned 8 years. Four years
later, with a reduction in the interest rate to 7%, the borrower seeks to settle the remaining
balance prematurely. The financial mathematical prepayment penalty, excluding credit
processing costs shall be calculated.

a) Calculation of the monthly rate

Excel Command: =PMT(9%/12, 8*12, -300000)

Result: $4395,06

Here, the annual interest rate is divided by 12 to get the monthly rate, the number of periods
is the total number of months (8 years * 12 months per year), and the loan amount is negated
to represent a cash outflow.

b) Remaining loan balance

To determine the remaining loan balance after 4 years of monthly payments, you can utilize
the following formula:

Excel Command: =300000 + CUMPRINC(9%/12, 96, 300000, 1, 48, 0)

This formula combines the original loan amount of €300,000 with the cumulative principal
payments made over the first 4 years. Let's break down the components:
Original Loan Amount (€300,000): This is the initial loan amount.
40
CUMPRINC Function: =CUMPRINC(interest_rate, periods, loan_amount, start_period,
end_period)
This Excel function calculates the cumulative principal payment over a specified range of
periods. In this case:
Interest Rate (9%/12): The monthly interest rate calculated from the annual rate.
Total Number of Periods (96): The total number of monthly payments over the entire loan
term (8 years * 12 months per year).
PV (Present Value, €300,000): The initial loan amount.
Start Period (1): The period from which cumulative principal payments begin.
End Period (48): The period up to which cumulative principal payments are calculated.
Type (0): Specifies that payments are due at the end of the period.
The result of this formula is the remaining loan balance after 4 years of monthly payments. It
considers the cumulative reduction in principal over the specified period.

Result: $176,614.57

c) Reinvestment of the Repaid Residual Balance

To explore the reinvestment of the repaid residual balance of $176,614.57, considering a
monthly interest rate of 7%12 for 48 months, you can employ the following Excel function to
determine the resulting monthly payment:
=PMT(7%/12, 48, -176614.57)

Result: $4,229.26

d) Damage for Lender (Bank)

The monthly damage for the lender is computed as the difference between the two payments:
=PMT(9%/12, 96, -300000) - PMT(7%/12, 48, -176614.57)
=4395.06-4229.26=165.80.
Breaking down the calculation:
The first part calculates the monthly payment for the original loan at an interest rate of 9% per
annum, with a loan term of 8 years.
The second part calculates the monthly payment for reinvesting the repaid residual balance of
$176,614.57 at a reduced interest rate of 7%/12 for 48 months.
The result of this calculation is $165.80, which represents the monthly damage for the lender.
To determine the total damage, we calculate the present value of the monthly reduced
payments over 48 months using the monthly discount rate of 7/12%, which is the financial
mathematical prepayment penalty:

=PV(7%/12, 48, -165.80)

This formula calculates the present value of the reduced monthly payments, resulting in a
financial mathematical prepayment penalty which is $6,923.84

Comparatively, the financial mathematical prepayment penalty is lower than the penalty of
the usual banking practice. The typical banking practice often involves a simpler formula for
the prepayment penalty:

Prepayment Penalty=Remaining Loan Balance×(Initial Interest Rate−Current Interest Rate)×

Remaining Time

41
where:
Remaining Loan Balance: The outstanding amount to be repaid.
Initial Interest Rate: The interest rate at the time of loan initiation.
Current Interest Rate: The current interest rate.
Remaining Time Period: The time remaining until the loan's original maturity.

Result of the simple formula:

9 7
176614.57     %  48  14129.16
 12 12 

In the assessment of prepayment penalties, it becomes evident that the traditional banking
formula often favors lenders, resulting in higher penalty amounts compared to more accurate
financial mathematical calculations. The discrepancy underscores the importance of
borrowers thoroughly reviewing loan agreements to comprehend the implications of early
repayment.
The financial mathematical approach, considering the present value of reduced monthly
payments, provides a more precise representation of the actual cost associated with settling a
loan ahead of schedule. This knowledge empowers borrowers to make informed decisions
and, when possible, engage in negotiations with lenders for fair and transparent prepayment
penalty terms. As the financial landscape evolves, borrowers benefit from an understanding
of these intricacies, ensuring a more equitable and informed lending environment.

Summary
EXCEL Formulas Used to Calculate the Penalty Payment:

a) Monthly payment for the original loan:

=PMT(9%/12, 96, -300000)
b) Remaining loan balance after 4 years:
=300000 + CUMPRINC(9%/12, 96, 300000, 1, 48, 0)
c) Monthly payment for reinvesting the repaid residual balance:
=PMT(7%/12, 48, -176614.57)
d) Present value of the reduced monthly payments for the financial mathematical prepayment
penalty:
=PV(7%/12, 48, -165.80)

A nested function for the penalty payment, combining the monthly payments and the present
value calculation:

= PV(7%/12, 4*12, PMT(9%/12, 8*12, 300000)

- PMT(7%/12, 48, 300000 + CUMPRINC(9%/12, 96, 300000, 1, 48, 0))) = $6,924.06

42
4. Price and Duration of Bonds and other Securities
4.1 Price of a Bond (PRICE)

PRICE

This function is employed to determine the price of a bond or other security, assuming a face
value of $100. This function takes into account key parameters, such as the annual coupon
rate, the number of periods to maturity, the yield to maturity, and the redemption value.

Syntax: =PRICE(settlement, maturity, rate, yld, redemption, frequency, [basis])

Parameters:
settlement: Represents the settlement date of the security. It signifies the date when the
security is acquired, and it's the date used to calculate the security's price.
maturity: The maturity date of the security. It denotes the date when the security will be
redeemed.
rate: The annual coupon rate of the security, indicating the annual interest rate paid by the
security.
yld: The yield to maturity of the security, signifying the expected annual rate of return if the
security is held until maturity.
redemption: The redemption value or the face value of the security. It denotes the amount that
will be paid when the security matures.
frequency: Represents the number of interest payments per year. It can be set to 1 for annual
payments, 2 for semi-annual payments, and so forth.
basis: An optional argument specifying the day count basis to use in the calculation. If
omitted, it defaults to 0 (or 1 in Excel 365). Different financial markets and instruments may
utilize distinct day count conventions.

Day Count Basis Options:

The basis parameter in the PRICE function is optional and specifies the day count basis to use in the calculation.
Here are some common options:
0 (or 1 in Excel 365): US (NASD) 30/360 - Assumes a 30-day month and a 360-day year, with specific
adjustment rules.
1 (or omitted in Excel 365): Actual/actual - Uses the actual number of days between the settlement and maturity
dates, adjusted for leap years.
2: Actual/360 - Calculates actual days between dates but assumes a 360-day year.
3: Actual/365 - Calculates actual days between dates but assumes a 365-day year.
4: European 30/360 - Similar to US (NASD) 30/360, but with different rules for adjusting the end date. Assumes
a 30-day month and a 360-day year.

Examples

Example 1: A 5-year bond is a) redeemed at 100 € b) redeemed at 105 €. The prevailing

market interest rate stands at 4%. Calculate the prices given a coupon interest rate of 4.5%.

a)
Excel Command: =PRICE("1/1/2023", "1/1/2028", 4.5%, 4%, 100, 1, 4)
Settlement date: January 1, 2023.
Maturity date: January 1, 2028 (5 years later).
Annual coupon rate: 4.5% (q=1.045).
Yield to maturity: 4% (q´=1.04).

43
 Redemption value (face value): $100.
Frequency: Annual payments.
Day count basis: 4.

100  q 'n  1  100  1.045  1 

Formula: K 0  n 1   q  1  1  0.045    102.23
q'  q ' 1  1.045  0.04 

b)
Excel Command: =PRICE("1/1/2023", "1/1/2028", 4.5%, 4%, 105, 1, 4)

Formula:
100  q 'n  1  P0 100  1.045  1  5
K0  n 
1   q  1  n  1  0.045    106.34
q'  q ' 1  q ' 1.045  0.04  1.045

Results: a) €102.23 b) €106.34

Example 2: Consider a zero bond that will be paid back in 10 years for $1,000 with a yield to
maturity of 4%. We want to determine the price of this zero bond.

Excel Command: =PRICE("1/1/2023", "1/1/2033", 0, 4%, 1000, 1, 0)

In this example:
Settlement date: January 1, 2023.
Maturity date: January 1, 2033 (10 years later).
Annual coupon rate: 0% (as it's a zero bond).
Yield to maturity: 4%.
Redemption value: $1,000.
Frequency: Annual payments.
Day count basis: 0 (or 1 in Excel 365, using US (NASD) 30/360).
This PRICE function calculates the present value of the future redemption value of $1,000
based on the specified parameters, including a yield to maturity of 4%. The result will be
the price of the zero bond.

Kn 1000
Formula: K0    675.56
q 'n 1.0410

Result: $675.56

Note: In the examples provided, we have illustrated scenarios where the bond's cash flows align neatly with full
periods, such as complete years. This simplifies the discounting calculations, making them straightforward and
aligned with the periodicity of the interest rate. It's worth noting that when cash flows span partial periods,
commonly referred to as 'broken periods,' the discounting formulas can become more intricate. Despite this
complexity, Excel commands, such as the PRICE function, remain user-friendly and can readily handle
calculations involving broken periods. For a comprehensive understanding of these intricacies, the reader is
encouraged to consult the official Microsoft Excel support, which provides extensive documentation and
resources on the Excel PRICE function. Microsoft's support also publishes the discounting formulas6.

6
(https://support.microsoft.com/en-us/office/price-function-3ea9deac-8dfa-436f-a7c8-17ea02c21b0a)

44
4.2 Average Security Maturity (DURATION and MDURATION)

DURATION

The function in Excel is used to calculate the Macaulay duration of a security with an
assumed par value of $100. It is the weighted average time to receive the bond's cash flows,
taking into account the present value of each cash flow.

Syntax: =DURATION(settlement, maturity, coupon, yield, frequency, [basis])

MDURATION

This function in Excel calculates the modified Macaulay duration of a security with an
assumed par value of $100. It approximately calculates the relative change in the bond's value
for a market interest rate change of 1 percentage point.

Syntax: =MDURATION(settlement, maturity, coupon, yield, frequency, [basis])

settlement: The settlement date of the security.

maturity: The maturity date of the security.
coupon: The security's annual coupon rate.
yield: The security's annual yield.
frequency: The number of interest payments per year.
[basis]: An optional argument that specifies the day count basis to use (see 4.1).

Example 1: Consider a 5% bond with a 5-year maturity and a redemption of 100%, assuming
an interest rate of 7%.
a) Calculate the duration.
b) Determine the approximate increase in the value of this bond if the interest rate decreases
by one percentage point.

Excel Commands:

a) =DURATION(A1, A2, 0.05, 0.07, 1)

b) =MDURATION(A1, A2, 0.05, 0.07, 1)

Assuming in A1 and A2 are the dates 01.01.19 and 01.01.24.

Formulas:
 q 'n  1 n 
  n 0.05  1.07  1.07  1  5   5
5
 
q  1   q ' 

  q ' 1 q ' 1 
2
 0.07 2 0.07 
D   4.5232
q ' 1
n
1.07  1
5
1   q  1 1  0.05 
q ' 1 0.07

D 4.5232
MD    4.227
q' 1.07

45
Results:
Duration: 4.52 years
Modified Duration: 4.23 (If the interest rate decreases by one percentage point from 7% to
6%, the bond's price will increase by approximately 4.23%).

Example 2: Assuming an interest rate of 7%, by how much will a 5% bond with a 5-year
maturity and a redemption of 100% exactly rise if the interest rate decreases by one
percentage point?

Excel Commands:

=PRICE(A1, A2, 0.05, 0.07, 100, 1)

=PRICE(A1, A2, 0.05, 0.06, 100, 1)

Assuming in A1 and A2 are the dates 01.01.19 and 01.01.24.

100  q 'n  1  100

 1.075  1 
Formulas: K0   
1  q  1  1  0.05    91.80
q 'n  q ' 1  1.075
 0.07 
100  q 'n  1  100  1.065  1 
K 0  n 1   q  1  1  0.05    95.79
q'  q ' 1  1.065  0.06 

Results:
7% Interest Rate: Price: $91.8
6% Interest Rate: Price: $95.79

An interest rate decrease of 1 percentage point from 7% to 6% leads to an increase in the

bond price from $91.8 to $95.79, corresponding to an increase of 4.34%, which is close to the
approximate value of 4.23% in Example 1.

Example 3: Assuming an interest rate of 7%, how will the price of a zero bond with a 5-year
maturity and a redemption of 100% change if the interest rate decreases by one percentage
point?

Excel Commands:

=PRICE(A1, A2, 0, 0.07, 100, 1)

=PRICE(A1, A2, 0, 0.06, 100, 1)

Assuming in A1 and A2 are the dates 01.01.19 and 01.01.24.

Kn 100
Formulas: K0    71.3
q 'n 1.075
K 100
K 0  nn   74.73
q' 1.065
Results:
7% Interest Rate: Price: $71.30
6% Interest Rate: Price: $74.73

46
An interest rate decrease of 1 percentage point from 7% to 6% leads to an increase in the zero
bond price from $71.30 to $74.73, corresponding to an increase of 4.81%.

Now, let's calculate the Duration and MDURATION for a zero bond with a 5-year maturity
and a redemption of 100%.

Excel Commands:

=DURATION(A1, A2, 0, 0.07, 1)

=MDURATION(A1, A2, 0, 0.07, 1)

Assuming in A1 and A2 are the dates 01.01.19 and 01.01.24.

Formulas: Dn 5
n 5
MD    4.67
q´ 1.07
Results:
Duration: 5 years
Modified Duration: 4.67

Remarks:

In the case of a zero-coupon bond (where the coupon rate is 0%), the duration is equal to the
bond's term to maturity.
The modified Macaulay duration is 4.67. The exact increase of 4.81% will be slightly
underestimated by the modified duration, which assumes an increase of only 4.67%.

47
5. Interest Rate Functions
5.1 Effective and Nominal Interest Rates (EFFECT and NOMINAL)

EFFECT
This function is used to calculate the effective annual interest rate based on a nominal interest
rate and the number of compounding periods per year.

Syntax: =EFFECT(nominal_rate, npery)

nominal_rate: The nominal interest rate per compounding period.

npery: The number of compounding periods per year.

NOMINAL

This function is used to convert the effective interest rate to a nominal interest rate based on
the number of compounding periods per year.

Syntax: =NOMINAL(effective_rate, npery)

effective_rate: The effective annual interest rate.

npery: The number of compounding periods per year.

Example 1: Consider a credit with a nominal interest rate of 10% per year, compounded
monthly. We want to determine the effective interest rate.

Excel Command: =EFFECT(10%, 12)

Formula:
 p 
m   10 
12 
peff  100   1    1  100   1    1  10.47
  m 100     12 100  
   

Result: 10.47 %

Example 2: Suppose the effective rate of an investment is 6.14%, and we want to find the
nominal interest rate per year with quarterly compounding.

Excel Command: =NOMINAL(6.14%, 4)

 p   6.14 
Formula: p  100  m   m 1  eff  1  100  4   4 1   1  6
 100  100
  

Result: 6%

48
Example 3: Suppose you aim for an effective interest rate of 12% per year with monthly
compounding in your credit offer. You want to calculate the nominal monthly interest rate
(pk) to advertise this offer.

Excel Command: =NOMINAL(12%, 12) / 12

 p   12 
Formula: p k  100   m 1  eff  1  100   12 1   1 =0.949
 100  100 
 

Result: Approximately 0.95%

Remarks:

Nominal interest rate: 12 * 0.95% = 11.4%

Effective interest rate: =EFFECT(12 * 0.95, 12) = 12%

Thus, the credit offer should be: "Our credit costs you only 0.95% monthly (with monthly
compounding)."

49
5.2. Interest (RATE) Function

RATE
This function calculates the interest rate per period of an annuity. An annuity is a series of
equal payments made at regular intervals, such as monthly or annually.

Syntax: =RATE(nper, pmt, pv, [fv], [type], [guess])

Parameters:
nper: The total number of payment periods.
pmt: The payment made each period; it remains constant throughout the annuity's life.
pv: The present value, or the total amount that a series of future payments is worth now.
[fv]: (Optional) The future value, or a cash balance you aim to attain after the last payment is
made. If omitted, it is assumed to be 0.
[type]: (Optional) The timing of the payment: 0 for the end of the period, and 1 for the
beginning. If omitted, it defaults to 0.
[guess]: (Optional) An initial guess for the rate. If omitted, Excel uses 10%.

In the calculation of interest, it is assumed that the interest accrual coincides with the
installment payment. For instance, in the case of monthly or quarterly payments, monthly or
quarterly interest accruals are assumed. The resulting interest rate is then a monthly or
quarterly rate, which can be converted to an annual rate using the EFFECT function (see 5.1).
When entering the arguments, it is crucial to ensure congruence between the term and the
periods of installment payments (e.g., a term of 4 years must be converted to a term of 48
months for monthly payments).
RATE utilizes an iterative process to calculate an interest rate. It is possible that there may be
no solution or multiple solutions. If the differences between successive results of RATE do
not converge after 20 iterations, RATE returns the error value #NUM!.

Examples

I. Interest calculation with annual payments given the future value of an annuity

Example 1: A saver invests €1,000 at the beginning of each year for 10 years. At the end of
the savings period, they have a balance of €13,208. What was the interest rate for this
investment?

Excel Command: =RATE(10, -1000, 0, 13208,1)

Rn qn 1 13208 q10  1
Formula:  q : q  q  1.05
r q 1 1000 q 1

The equation is solved through a systematic trial-and-error approach, reminiscent of the

regula falsi method.

Result: 5%

50
Example 2: A speculator invests €100,000 annually in arrears for 5 years in a silver mine.
After 5 years, the mine has a selling value of
a) €1,000,000
b) €500,000
What is the respective yield for each scenario?

Excel Commands:

a) =RATE(5, -100000, 0, 1000000)

b) =RATE(5, -100000, 0, 500000)
1 q 5  1 1000000
Formulas: a) 100000  5   0  q = 1.3524
q q 1 q5
1 q 5  1 500000
b) 100000  5  0 q=1
q q 1 q5
(systematic trial-and-error)
Results:
a) 35.24%
b) 0%

II. Interest Calculation with Annual Payments Given the Loan Amount

Example 3: A loan of €40,000 is amortized and paid off over 5 years through equal annuities
of €10,000. What is the interest rate of the loan?

Excel Command: =RATE(5, -10000, 40000)

A q 1 10000 q 1
Formula:  qn  n   q5  5
S q  1 40000 q 1
An iterative procedure, akin to the regula falsi method, yields the solution q=1.079308243

Result: 7.93%

III. Interest Calculation with Non-Annual Payments Given the Loan Amount

Example 4: Consider a computer costing €2,205 paid in cash. Opting for a partial payment
agreement, you commit to making 30 payments of €99.80 at the end of each month.
a) What is the monthly interest rate?
b) What is the effective annual percentage rate (APR) with monthly interest calculation?

Excel Commands:

a) = RATE(30, -99.8, 2205)

b) = EFFECT(12*RATE(30, -99.8, 2205),12)

2205 1 q 30  1
Formulas: a)  30   1.021 (systematic trial and error)
99.80 q q 1
b) 1.02112  1  0.2831
Results:
a) 2,1% b) 28.31 %
51
Example 5: From an advertisement for a credit offer: "Quick and easy: €15,000 for €282.05
per month, term: 6 years."
What is the effective annual percentage rate (APR)?

Excel Command: =EFFECT(12*RATE(6*12, -282.05, 15000),12)

15000 1 q 72  1
Formulas:  72   q  1.008789932 (systematic trial and error)
282.05 q q 1
Yearly effective interest rate: 1.00878993212  1  0.1107

Result: 11.07% (monthly 0.88%)

IV. Interest Calculation with Combined Annuity and Interest Payments

Example 6: An investor puts €100,000 immediately into an investment fund and then
annually adds €50,000 at the end of each year. After 10 years, the fund's value is €2,000,000.
What is the calculated annual rate of return or yield?

Excel Command: =RATE(10, -50000, -100000, 2000000)

q10  1
Formula: 100000  q10  50000   2000000  q = 1.2070
q 1
(systematic trial and error)

Result: 20.7%

Example 7: A retiree has an investment fund worth €1,000,000. He annually withdraws

€100,000 at the beginning of each year. After 10 years, the value of his fund has halved. What
is the interest rate or yield?

Excel Command: =RATE(10, -100000, 1000000,- 500000,1)

q10  1
Formula: 1000000  q10  100000  q   500000  0  q = 1.071
q 1
(systematic trial and error)
Result: 7.11%

V. Compound Interest Calculation

Example 8: What interest rate is offered if an amount of €1,000 grows to €1,229.25 after 6
years?

Excel Command: =RATE(6, 0, -1000, 1229.25)

Kn 1229.25
Formula: i  n 1  n  1  0.035
K0 1000

Result: 3,5%

52
5.3 Internal Rate of Return (IRR)

IRR

Returns the internal rate of return per period of a series of cash flows with both negative and
positive payments, which may not be of equal magnitude. Payments must occur at regular
time intervals (monthly, quarterly, annually, etc.).

Syntax: =IRR(values, [guess])

Remarks:

IRR assumes that the payments occur in the order in which they are specified in the "values"
argument. There must be at least one positive and one negative value for the internal rate of
return to be calculated.
Excel uses an iterative process to calculate the IRR function. In most cases, it is not necessary
to provide an initial guess. If the guess argument is missing, it is assumed to be 0.1 (10
percent).
If IRR returns the error value #NUM! or the result deviates significantly from the expected
result, the calculation should be repeated with a different guess.
In the case of annual payments, the internal rate of return is referred to as the Effective
Interest Rate for loans and the Yield or Return on Investment for financial investments.
However, in capital budgeting problems, the term "internal rate of return" is commonly used.
IRR provides the internal rate of return per period (month, quarter, etc.), which is usually
converted into an effective annual interest rate using the EFFECT function if the period is not
one year.
In specific cases, the internal rate of return can also be calculated using the functions RATE
and YIELD.

Examples

Example 1: An investor is faced with the decision of whether to proceed with an investment
(purchase of a tour bus) with the following (estimated) cash flow series: -660,000 124,600
149,000 173,400 503,400; the last cash flow includes the sales proceeds of the tour bus. The
initial investment occurs at time 0. The discount rate is 10%. Calculate the internal rate of
return of this investment.

Excel Command: =IRR({-660000, 124600, 149000, 173400, 503400}, 0.1)

Formula: 660000  124600 / q  149000 / q 2  173400 / q 3  503400 / q 4  0  q = 1.1276

The equation is solved through a systematic trial-and-error approach, reminiscent of the

regula falsi method.

Result: 12.76%

Given an internal rate of return (IRR) of 12.76%, which exceeds the hurdle rate of 10%, it can
be concluded that the investment is profitable.

53
Example 2: A loan of €980 is taken out. Repayments are made in four monthly installments
of €250 each. What is the effective interest rate? What would be the effective interest rate if
the last installment were not €250 but €270?

Excel Commands:

a) =EFFECT(12*RATE(4, -250, 980),12)

b) =EFFECT(12*(IRR({-980, 250, 250, 250, 270})),12)

1 q4 1
Formulas: a) 980  250  4  0  q  1.0081
q q 1
1.008112  1  0.102

250 250 250 270

b) 980   2  3  4  0  q  1.0160
q q q q
1.016  1  0.2099
12

(systematic trial and error)

Results:
a) 10.2%
b) 20.99%

Example 3: A foreign bond with a nominal interest rate of 8% is purchased at a market value
of €104.6 and sold after 6 years at a market value of €92.66. What is the internal rate of return
or yield? What would be the yield if the coupon payments were 10% in the last two years
instead of 8%?

Excel Commands:
a) =RATE(6, 8, -104.6, 92.66)
b) =IRR({-104.6, 8, 8, 8,8, 10, 10+92.66}) (Assuming annual payments)

8 q 6  1 92.66
Formulas: a) 104.6  6   6  0  q  1.0601
q q 1 q
8 q 4  1 10 10 92.66
b) 104.6      6  0  q = 1.0659
q 4 q  1 q5 q6 q
(systematic trial and error)
Results:
a) 6,01%
b) 6.59%

54
5.4 Modified Internal Rate of Return (MIRR)

MIRR
It calculates the rate of return on an investment when there are different financing and
reinvestment rates. MIRR considers the cost of financing (or discount rate) and the rate of
return on reinvested cash flows.

Synatx: =MIRR(cash_flows, finance_rate, reinvest_rate)

Parameters:
cash_flows: The range of cells that contains the cash flows. This includes both positive and
negative cash flows.
finance_rate: The financing rate, which represents the cost of capital or the rate at which
negative cash flows are discounted.
reinvest_rate: The rate of return on reinvested cash flows, representing the rate at which
positive cash flows are assumed to be reinvested.

Remarks:

MIRR assumes that the cash flows occur in the order specified in the values. At least one
positive and one negative value are required for an interest rate to be calculated. If an interest
rate is not provided, a value of zero is assumed.
With MIRR, the negative cash flows of an investment are discounted to time zero using the
financing rate, while the positive cash flows are reinvested and compounded to time n (end of
the investment) with the reinvesting rate. MIRR is then calculated from the ratio of these two
sums, as demonstrated in the following example:

Example 1: The following cash flow series represents an investment:

t 0 1 2 3 4 5
cash flows -100 50 50 -30 50 50

In order to finance the negative cash flow at time t=3, a discounted savings bond with a 4%
interest rate is purchased today. The investor's required rate of return is 12%. What is the
yield on the invested capital?

A B C D E
1 t Cash Flow Financing Cash Flow 1 Cash Flow 2
2 0 -100 -26.67 -126.67 -126.67
3 1 50 50.00 0.00
4 2 50 50.00 0.00
5 3 -30 30 0.00 0.00
6 4 50 50.00 0.00
7 5 50 50.00 254.92
8
9
10 IRR 21.56%
11 MIRR 15.01% 15.01% 15.01%

55
The investor acquires a savings bond at a discounted market value of $26.67, resulting in a
total investment amount of $126.67. The maturity payout of the savings bond at time 3
30
effectively covers the negative cash flow. (formula:  26, 67 )
1.043

Cash flows are reinvested at a rate of 12% until the end of the investment at time t=5,
resulting in a final capital of $254.92. Calculating the yield involves relating the final capital
of $254.92 (formula: 50  1.12 4  50  1.123  0  50  1.121  50 ) to the initial investment sum of $126.67,
yielding a return of 15.01% (as shown in cell E11 using the formula =RATE(5,0,E2,E7),
which is equivalent to the MIRR of the original cash flow series in cell B11 using the formula

=MIRR(B2:B7,4%,12%)).

The internal rate of return (IRR) is calculated to be 21.56% in cell B10 (=IRR(B2:B7)),
representing the yield on the invested or tied-up capital. Alternatively, MIRR is obtained from
the cash flow after financing in cell D11 (=MIRR(B2:B7,12%,12%)).

The calculation of MIRR with the cash flow series in column E clearly illustrates the
interpretation of MIRR: it reflects the profitability of the invested capital. If we invest
$126.67 at a rate of 15.01% with yearly compounding, we would have $254.92 after 5 years.
It's essential to note that the internal rate of return reflects only the yield on the invested or
tied-up capital, whereas the modified internal rate reflects the overall profitability of the
starting capital.

Summary:

Discounted Savings Bond Purchase:

Cell C2: =PV(4%,3,0,-C5): Calculates the discounted market value of the bond.

Yield Calculation:
Cell E11: =RATE(5, 0, E2, E7) =MIRR(E2:E7,0%,12%): Calculates the rate of return that
links the final capital of $254.92 to the initial investment of $126.67. This results in a yield of
15.01%.

Internal Rate of Return (IRR) Calculation:

Cell B10: =IRR(B2:B7): Calculates the internal rate of return for the original cash flow series.
Represents the yield on the invested or tied-up capital.

Modified Internal Rate of Return (MIRR) Calculation:

Cell B11: =MIRR(B2:B7, 4%, 12%): Calculates the MIRR using the original cash flow series.
Cell D11: =MIRR(D2:D7, 0%, 12%): Calculates an alternative MIRR using the cash flow
series after financing. This demonstrates the application of MIRR with a different approach.

The calculation of IRR and MIRR for series E (Cash Flow 2) results in equal values. This is
because, in series E, there is only a negative cash flow at time 0 and a positive cash flow at
time 5. Since there are no intermediate cash flows to be reinvested or financed, both IRR and
MIRR yield the same rate, providing a straightforward illustration of their equality in this
specific scenario.

56
 n
 ct  q nr t
t 0
Formula: MIRR  n n
1
 c t  q f t
t 0

For a cash flow series c0, c1, c2, ... cn with negative ( ct ) and positive ( c t ) cash flows, the
profitability of an investment is calculated by above formula,considering the cash flow at
p p
time t to be either zero, positive, or negative; q r  1  r and q f  1  f (pr = reinvesting
100 100
rate; pf = financing rate).

Example 2: An investor is faced with the decision of whether to proceed with an investment
(purchase of a tour bus) with the following (estimated) cash flow series: -€660,000, €124,600,
€149,000, €173,400, €503,400; the last cash flow includes the sales proceeds of the tour bus.
The initial investment occurs at time 0. The incoming cash flows are reinvested at a rate of
10%. Calculate the return on investment of the initial payout of €660,000.

Exel Commands:

=FV(10%,3,0,-124600)+FV(10%,2,0,-149000)+FV(10%,1,0,-173400)+FV(10%,0,0,-503400)
Wealth after 4 years: $1,040,272.6;

=RATE(4,0,-660000,1040272.6)
ROI: 12.05%;

=MIRR({-660000,124600,149000,173400,503400},0%,10%)
ROI: 12.05%;

Formula:
n
 ct  q nHt c1q3H  c2 q 2H  c3q1H  c 4
t 0
MIRR  n n
1 n
1
  c0
n
c t  qS t
t 0 t 0

124600 1.13  149000 1.12  173400 1.11  503400 1040272.6

4 1  4  1  0.1205
660000 660000

Result: 12.05%

57
5.5 Yield of a Fixed-Income Financial Security (YIELD)

YIELD
This function is used to calculate the yield of a financial instrument, such as a bond, based on
its price and other relevant parameters. It is particularly useful for fixed-income securities.

Syntax: =YIELD(settlement, maturity, rate, pr, redemption, frequency, [basis])

Paramters:
- settlement: The settlement date of the security, when it is purchased.
- maturity: The maturity date of the security, when it will be redeemed.
- rate: The annual coupon interest rate of the security.
- pr: The price per €100 face value of the security.
- redemption: The redemption value or face value of the security.
- frequency: The number of interest payments per year (e.g., 1 for annual, 2 for semi-annual).
- [basis]: Optional. The day count basis to use for calculations (default is 0).

0 or omitted: US (NASD) 30/360

1: Actual/actual
2: Actual/360
3: Actual/365
4: European 30/360

Example: A European investor calculates the yield of a bond with a settlement date of
January 1, 2023, a maturity date of January 1, 2028, a 5% annual coupon interest rate, a
purchase price of €98 per €100 face value, a face value of €100, and annual interest payments.
What is the result of the calculation?

Excel Command: =YIELD("01-Jan-2023", "01-Jan-2028", 0.05, 98, 100, 1, 4)

100  q '5  1 
Formula: 98  1  0.05    0  q = 1.0547
q '5  q ' 1 
(systematic trial and error)

Exact Result: 5.47%

Note: The yield of a bond can be approximated using the current yield (CY) and yield to
maturity (YTM).

Current Yield = (Annual Interest Payment / Current Market Price) * 100

5
CY  100  5.1%
98

YTM ≈ (Annual Interest Payment + (Face Value - Current Market Price) / Years to Maturity)
/ ((Face Value + Current Market Price) / 2)*100
2
5
YTM  5 100  5.46%
99

58
The exact yield of 5.47% obtained through systematic trial and error may slightly differ from
the approximate values calculated using current yield and yield to maturity formulas.
Investors can use YTM as a quick and reliable tool to gain an initial understanding of the
bond yield.

Related Yield Functions

These functions are also valuable tools for analyzing fixed-income securities:

YIELDMAT

The YIELDMAT function is similar to YIELD but is specifically designed for securities that
pay interest only at maturity.

Syntax: =YIELDMAT(settlement, maturity, issue, rate, pr, [basis])

YIELDPRICE

The YIELDPRICE function calculates the price of a security based on its yield to maturity
(YTM).

Syntax: =YIELDPRICE(settlement, maturity, rate, yld, redemption, frequency,

[basis])

YIELDDISC

The YIELDDISC function calculates the annual yield of a discounted security.

Syntax: =YIELDDISC(settlement, maturity, pr, redemption, [basis])

For more details and examples about these functions and their applications, refer to Microsoft
Excel handbooks.

59
 5.6 Internal Rate of Return (XIRR)

XIRR
This function is used to calculate the internal rate of return for a series of cash flows that
occur at irregular intervals. It takes into account both the values (cash flows) and their
corresponding dates. The result will be the rate of return that makes the present value of the
chosen cash flows equal to zero, considering their respective dates.

Syntax: XIRR(values, dates, [guess])

values: An array or range of cash flows.

dates: An array or range of corresponding dates for each cash flow.
[guess]: Optional. An initial guess for the internal rate of return. If omitted, Excel uses 0.1
(10%).

Example: Suppose you have the following cash flows on specific dates:

Date Cash Flow

1-Jan-22 -1000
15-Mar-22 500
30-Jun-22 300
20-Dec-22 250

Let's assume the dates are in cells A2 to A5, and the cash flows are in cells B2 to B5.
Calculate the internal rate of return.

Excel Command: =XIRR(B2:B5, A2:A5)

Formula: 1000  500  q  73/365  300  q 180/365  250  q 353/365  0  q = 1.1115

(systematic trial and error)
Result: 11.15%

60

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