Deferred Annuity

PVAn-1 (As an annuity due) FVAn-1 (As an annuity due)

PVAn-1 (As an ordinary annuity)

FVAn-1 (As an ordinary annuity)

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?

• According to ordinary annuity, find the present value of this annuity

today (n=0).
•
• =13579.4769

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• In order to find the value at time 0:
• ×(=5235.4762

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?

• According to ordinary annuity, find the present value of this annuity today
(n=0).
• =6334.9262
• )=)
=14937.4246

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 • In order to find the value at time 0:
• ×(=5235.4762
• Future value of annuity due at time n=10
• 14937.4246×(

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Example 19:
• Mr. X has decided to invest 2400 at the beginning of every 6 month
period. He did so for 5 years. Due to some financial problems, he
could not make the payment for next 3 years. He again invested 3600
per 6 months for the next 4 years from the beginning of the 9th year.
Find the amount to hiscredit at the end of 12th year, assuming
interest at the rate of 9% per annum compounded semi-annually.

FVA
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 st
1 Annuity Due 2nd Annuity Due

1st Annuity Due

• ) = 30818.83 (At the end of 5th year)

nd
• FVAAnnuity
2 Due(At the end of 12th year)
= ) = 35287.61
• In order to sum up them: 30818.83= 57074.77 (At the end of 12th year)
• As a result, the total future value of this annuity = 57074.77+ 35287.61 = 92362.38

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Perpetuity

•
• [-]
• PVP = 0

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Example 17:
• Find the present value of a sequence of payments of 800 made at the
end of each year continuing forever, if money is worth at 5% annually?

• PVP =
• PVP = 800
PVP = 16000
•17.03.2024 9
Example 18:
• Ali and Burak have inheritance from their grandparents. 1000 TL will
be paid for Ali in each end of the 6th months and 1800 TL will be paid
for Burak in each end of the years. If the money worth 10%
compounded semi-annually, find the present values of inheritance.
• (!Note: Inheritance shows that the payments will continue forever)
• Ali=> t=2 r = = = 0.05
• PVP = 1000 (for Ali)

• Burak=>
• =0.1025
• PVP = 1800 (for Burak)

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 FORMULAS
ORDINARY ANNUITY ANNUITY DUE PERPETUITY

PRESENT x(1+i) =
VALUE

FUTURE )
VALUE

17.03.2024 11
 PRACTICE QUESTIONS
1.A certain bank offers an interest rate of 6% per annum compounded
annually. A competing bank compounds its interest continuously.
What nominal rate should the competing bank offer so that the
effective rates of two banks will be equal?
• (Ans. 5.82%)
• 2. John deposits an amount of money in a bank for 16 years at the
effective rates of interest 3% per annum for 10 years,
• 4% per annum for 4 years and
• 5% per annum for the last two years.

• His wife deposits the same amount in another bank at a constant force
of interest. After 16 years if both John and his wife get same
accumulated amount, at what rate of interest his wife deposited her
money?
• (Ans. 3.43%)
• 3. A man buys car on instalment basis such that he pays $ 50,000 on
signing of the contract and remaining in 4 equal instalments of $ 20,000;
the first is being paid at the end of first year and so on for each year. If
the rate of interest is 8% effective, find the cash price of the car?
• (Ans. $116,242.54)

• 4. A person decides to put aside $ 150 at the beginning of every month

in a money market fund that pays interest at the rate of 9% compounded
monthly. How much money does he have at the end of one year?
• (Ans. $1,890.21)
• 5. In how many years an investment of 5.000 TL will amount to 7.000
TL, if it is invested at 8% compounded quarterly? (Ans: 4,25 years)

• 6. The differences between simple interest and compound interest on

a sum for 3 years at 5% per annum is 76,25 TL. Find the sum? (Ans:
10.000TL)
 LOAN AMORTIZATION
• Example 20: A loan of 30000 is to be amortized by equal payments at
the end of each year for 5 years, if the interest is calculated at the rate
of 6% per annum compounded annually, find annual payment and the
total interest paid.

• CF = 7121.89 (Annual Payment)

 Rest of the Debt
Interest payment Principal
Year Debt CF at the end of the period
(Debt x Interest Rate) (CF – Interest Payment)
(Debt - Principal)

1 30000 7121.89 30000 x 0.06 = 1800 7121.89 – 1800 = 30000 – 5321.89 =

5321.89 24678.11
24678.11 x 0.06 = 7121.89 - 1480.69 = 24678.11 - 5641.204 =
2 24678.11 7121.89 1480.69 5641.204 19036.90
19036.90 - 5979.67 =
3 19036.90 7121.89 19036.90 x 0.06 = 7121.89 - 1142.21 = 13057.22
1142.21 5979.67

4 13057.22 7121.89 13057.22 x 0.06 = 7121.89 - 783.43 = 13057.22 - 6338.46 =

783.43 6338.46 6718.76
5 6718.76 7121.89 6718.76 x 0.06 = 7121.89 - 403.13 = 6718.76 - 6718.76 = 0
403.13 6718.76
Total Interest payment = 5609.46
Example 21:
• A loan of 1500 is being repaid semiannually at the end of each
semiannual for 3 years at 6% convertible semiannually.

• 1500
• CF = 276.8963
 Interest payment Principal Rest of the Debt
Year Debt CF (Debt x Interest Rate) (CF – Interest Payment) at the end of the period
(Debt - Principal)

1 1500 276.8963 45 231.8963 1268.1037

2 1268.1037 276.8963 38.0431 238.8532 1029.2505

3 1029.2505 276.8963 30.8775 246.0188 783.2317

4 783.2317 276.8963 23.4970 253.3993 529.8324

5 529.8324 276.8963 15.8950 261.0013 268.8311

6 268.8311 276.8963 8.0650 268.8311 0

INTEREST RATE % 1,25
NUMBER OF EQUAL PAYMENT 12
Monthly
Date Payment Interest Payment Principal payment Balance
Tarih AylıkÖdeme faiz ödemesi Anapara ödemesi Kalan Anapara
0 15.11.2016 0 0 0 10000
1 15.12.2016 900 121 779 9221
2 15.01.2017 900 112 789 8432
3 15.02.2017 900 102 798 7634
4 15.03.2017 900 92 808 6826
5 15.04.2017 900 83 818 6008
6 15.05.2017 900 73 828 5180
7 15.06.2017 900 63 838 4342
8 15.07.2017 900 53 848 3495
9 15.08.2017 900 42 858 2637
10 15.09.2017 900 32 868 1768
11 15.10.2017 900 21 879 889
12 15.11.2017 900 11 890 0
 Loan Amortization Table
1000
800
600
400
200
0
1 2 3 4 5 6 7 8 9 10 11 12
Series1 Series2
N=36 İ=% 1,25
Tarih Taksit faiz ödemesi Anapara ödemesi Kalan Anapara
0 28.10.2016 0 0 0 50000
1 28.11.2016 1733.26 625 1108.26 48892
2 28.12.2016 1733.26 611.14675 1122.11325 47770
3 28.01.2017 1733.26 597.1203344 1136.139666 46633
4 28.02.2017 1733.26 582.9185886 1150.341411 45483 LOAN AMORTIZATION
5 28.03.2017 1733.26 568.5393209 1164.720679 44318 2000
6 28.04.2017 1733.26 553.9803124 1179.279688 43139 1800
7 28.05.2017 1733.26 539.2393163 1194.020684 41945 1600
8 28.06.2017 1733.26 524.3140578 1208.945942 40736 1400
9 28.07.2017 1733.26 509.2022335 1224.057766 39512 1200
10 28.08.2017 1733.26 493.9015114 1239.358489 38273 1000
11 28.09.2017 1733.26 478.4095303 1254.85047 37018 800
12 28.10.2017 1733.26 462.7238994 1270.536101 35747 600
13 28.11.2017 1733.26 446.8421982 1286.417802 34461 400
14 28.12.2017 1733.26 430.7619757 1302.498024 33158
200
15 28.01.2018 1733.26 414.4807504 1318.77925 31840
0
16 28.02.2018 1733.26 397.9960097 1335.26399 30504 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
17 28.03.2018 1733.26 381.3052099 1351.95479 29152
18 28.04.2018 1733.26 364.405775 1368.854225 27784 Series1 Series2
19 28.05.2018 1733.26 347.2950972 1385.964903 26398
20 28.06.2018 1733.26 329.9705359 1403.289464 24994
21 28.07.2018 1733.26 312.4294176 1420.830582 23574
22 28.08.2018 1733.26 294.6690353 1438.590965 22135
23 28.09.2018 1733.26 276.6866482 1456.573352 20678
24 28.10.2018 1733.26 258.4794814 1474.780519 19204
25 28.11.2018 1733.26 240.0447249 1493.215275 17710
26 28.12.2018 1733.26 221.3795339 1511.880466 16198
27 28.01.2019 1733.26 202.4810281 1530.778972 14668
28 28.02.2019 1733.26 183.346291 1549.913709 13118
29 28.03.2019 1733.26 163.9723696 1569.28763 11549
30 28.04.2019 1733.26 144.3562742 1588.903726 9960
31 28.05.2019 1733.26 124.4949776 1608.765022 8351
32 28.06.2019 1733.26 104.3854149 1628.874585 6722
33 28.07.2019 1733.26 84.02448254 1649.235517 5073
34 28.08.2019 1733.26 63.40903858 1669.850961 3403
35 28.09.2019 1733.26 42.53590156 1690.724098 1712
36 28.10.2019 1733.26 21.40185033 1711.85815 0
 NET PRESENT VALUE (NPV)
(financial decision making)

• Economic life of investment = N

• Cost of Capital (discount rate) = k
• Salvage Value = H/S (cash inflow (+))
• Initial Investment = (cash outflow (-))
• For N= 5
• NPV = [++++] -
• NPV = -
• If NPV > 0 ACCEPT
• If NPV< 0 REJECT
 EXAMPLE 22:
• Economic Life = 5
• Cost of Capital = 10%
• Salvage Value = 0
• CF = 10000
• Initial Investment = 25000
• NPV = [++++] -
• NPV = 10000[] – 25000
• NPV = 12907.86 > 0 => ACCEPT
• What if, k = 5%, 15%, 20%, 25%, 30% ?
• For k = 5%
NPV = 10000[] – 25000
NPV = 43294.767 – 25000
NPV = 18294.767 > 0 ACCEPT
• For k = 15%
NPV = 10000[] – 25000
NPV = 33521.551 – 25000
NPV = 8521.551 > 0 ACCEPT
• For k = 20%
NPV = 10000[] – 25000
NPV = 29906.121 – 25000
NPV = 4906.121 > 0 ACCEPT
• For k = 25%
NPV = 10000[] – 25000
NPV = 26892.8 – 25000
NPV = 1892.8 > 0 ACCEPT
• For k = 30%
NPV = 10000[] – 25000
NPV = 24355.697 – 25000
NPV = -644.303 < 0 REJECT
• For k = 40%
NPV = 10000[] – 25000
NPV = 20351.64 – 25000
NPV = -4648.36 < 0 REJECT
 NET PRESENT VALUE
25000.00

20000.00
INTERNAL RATE OF RETURN (IRR)
15000.00
NPV

10000.00

5000.00

0.00
0.05 0.10 0.15 0.20 0.30
DISCOUNT RATE
 EXAMPLE 23:
• A company gets a contract and realises 7% annual return from the
contract. The company expects to realise $70000 at the end of every
year for 5 years. However accepting the contract requires capital
expense of $250000 at present. Should the company accept the
contract?

NPV = 70000[] – 250000

NPV = 287013.8205 – 25000
NPV =37013.8205> 0 ACCEPT
 EXAMPLE 24:
• Jordan Cor. a maker of casual, is considering a Project. Because of
past financial difficulties, the company has a high at 15%. The initial
investment of that Project is $60000. Cash flows of the project is
$25000 for 3 years. Calculate NPV of Project.

NPV = 25000[] – 60000

NPV = 57080.063 – 60000
NPV =-2919.937 < 0 REJECT
EXAMPLE 25:
• Suppose an investor is asked to invest 1000 and is promised in return
a payment of 600 in one year and 550 in the second year. What
interest rate is the investor earning on his/her invested money?

NPV = [600()+550 ()]-1000

Substitute with x;
NPV = 0;
1000 = 600 + 550
550+ 600 – 1000 = 0
55+ 60 – 100 = 0
(5+10)(11) = 0
(11) = 0
=> =
= => k = 0.10
 BOND VALUATION

Interest Payment

• B=I +
Maturity

Price of Bond
Nominal Price (Par Value)
 NOTATIONS
• B = Price of Bond
• M = The par value, face value, nominal price,redemption value
• i = Market interest rate
• r = Coupon interest rate
• I = M x r (Interest payment) (Amount of the coupon)
 EXAMPLE 26:
• A bond with a nominal price of 3500 matures 15 years. The nominal
rate of interest on bond is 12% per annum paid annually. What should
be the price of the bond so as to yield effective rate of return equal to
10%.
• Nominal price (M) = 3500
• Maturity (N) = 15
• Interest payment (M x r) = 3500 x 0.12 = 420 (I)
• B = 420 +
• B = 4032.4256

If B > M => The bond is said to sell at a Premium

• (B - M) = Premium
If B < M => The bond is said to sell at a Discount
• (M - B) = Discount

4032.4256 > 3500 => The bond is said to sell at a Premium.

 If i = 5%, 15%, 20%, 30% => B=?
bond valuatı on
7000.00
6043.02
6000.00

5000.00
4032.43
prıce of bond

4000.00
2886.03
3000.00
2190.87
2000.00 1441.03
1000.00

0.00
0.05 0.10 0.15 0.20 0.30
market ınterest rate
 EXAMPLE 27:
• A 10 year 1000 par bond with 8% semiannual coupons is callable
in 7 years. At what price should an investor buy the bond to yield
7.2% convertible semiannually?
• I = M x r => I = 1000 x () = 40
• B = 40 + 1000(
• B = 433.90 + 609.4855
• B = 1043.39