capital market

lesson 2

Presented by:
Caberos, Marlyn M.
Guerrero, Gillie
lesson 2
Mathematics of Finance

• The Importance of the Time Value of Money

• Determining the Future Value
• Determining the Present Value
• Determining the Number of Compounding
Periods
 time value of money
- is defined as a concept that states that purchasing
power of money differs with the passage of time.

REASON 1.
t
REASONS FOR
Cash flows occurring
CONCEPT at different points in time
have different values relative to any one point in
time.
 time value of money
- is defined as a concept that states that purchasing
power of money differs with the passage of time.

REASON 2.
t
REASONS FOR
CONCEPT
Cash flows are uncertain. Expected cash flows may not
materialize. Uncertainty stems from the nature of
forecasts of the timing and/or the amount of cash flows.
 IMPORTANCE OF THE TIME VALUE OF MONEY

• TVM and Compounding

- TVM helps calculating the PV interest earned on investment as well as on interest
itself too.
• Financial Management and TVM
- One should compare PV of benefits with the opportunity cost for decision making.
• Capital Budgeting and TVM
- While deciding for which investment to opt, one should consider the PV of cash flow.
• Personal Finance Decisions TVM
- TVM is an important concept to be considered before buying an insurance, renting
property, or buying one in future.
• Investing and TVM
- TVM helps in considering inflation, risk and investment opportunity before investing.
 DETERMINANTS OF TIME VALUE
OF MONEY

OPPORTUNITY
COST

The dollar cost of each purchase is the actual

amount of money spent, but when you spend
money, you also lose other things.
 DETERMINANTS OF TIME VALUE
OF MONEY
INTEREST RATE
Interest rate work as a
way to calculate the time
value of money because
they are determined by the
market as a whole. A rise
or fall in interest affects
TVM.
2 interest Compensation
• It consists of compensation for the
length of time the money is
borrowed.
• Compensation for the risk that the
amount borrowed will not be
repaid exactly as set forth in the
loan agreement.
 determining the future value and
present value
- Determining the future value (FV) and present value (PV) of an investment involves
calculations based on certain parameters like the initial investment amount, interest rate,
time period, and compounding frequency.
• Future or ( Maturity) Value
-It can be defined as the rising value of today’s sum at a specified future date given at a
specified interest rate. The formula to calculate the future value of an investment is:
n
FV=PV(1+r)
Where:
• FV = Future Value
• PV = Present Value (initial investment)
• r = Interest Rate per period (expressed as a decimal)
• n = Number of periods
 Principal at the
1,000.00
beginning
Interest for one year (1000*0.10) 100
First Year :
Principal at the end 1,100.00

Principal at the
1,100.00
beginning
Second Year: Interest for the year (1100*0.10) 110

Principal at the end 1,210.00

Principal at the
1,210.00
beginning

Third Year: Interest for the year (1210*0.10) 121

Principal at the end 1,331.00

Future Value Calculation Example:
• Let's say Mr. A invests $1,000 for say 3 years and 10% interest rate
compounding annually.

FV= PV(1+r) n
3
FV= 1000 (1+0.10)
3
FV = 1000 (1.10)
FV=1000 × 1.331
FV =1331

So, the future value of the investment after 3 years would be approximately
1331.
 2. PRESENT (principal) VALUE
- It can be defined as today’s value of a single payment or series of
payments to be received at a later date, given at a specified discount rate.
The process of determining the present value of a future payment or a series
of payments or receipts is known as discounting.
The formula to calculate the present value of an investment is:
PV = FV / (1+r) n
Where:
• FV = Future Value
• PV = Present Value (initial investment)
• r = Interest Rate per period (expressed as a decimal)
• n = Number of periods
Present Value Calculation Example:
• Mr. A has an offer to get $1331 after 3 years if he pays $975 today. A
market interest rate is 10% with annual compounding. To decide whether
he should pay $975 or not, he should be able to compare his proposed
outflow of today with today’s value of $1331 to be received after 3 years.
We know that the present value of $1331 after 3 years is $1000. So, Mr.
A should definitely pay $975 because there is a clear-cut benefit of $25
over and above the interest earnings.

n
PV = FV / (1+r)
3
PV = 1331 / (1+0.10)
3
PV = 1331 / (1.10)
PV= 1331 / 1.331
PV= 1000
 determining the number of compounding periods

- Determining the number of compounding periods involves figuring out how many times interest is
compounded over a given period. The number of compounding periods depends on the interest rate, the
frequency of compounding, and the duration of the investment or loan.
Step 1: Identify the PV, FV, and the nominal interest rate (both I/Y and C/Y).
Step 2: Solve for the periodic interest rate (i) using the formula :
i = I/Y over C/Y
Step 3: Use the formula for the future value, rearrange, and solve for n.
FV= PV(1+r) n
Step 4: Convert n to years and months.
YEARS = n over C/Y
• FV= Future value or maturity value C/Y = Compounds per year
• PV= Present value or principal value ln = Natural logarithm
• i = Periodic interest rate
• I/Y = Nominal interest rate per year
• n = Total number of compounding periods
Compounding Period Calculation Example:
• Jenny Holdings invested $43,000 at 6.65% compounded quarterly. A report from
the finance department shows the investment is currently valued at $67,113.46.
How long has the money been invested?
Step 1: Given variables:
PV = $43,000; I/Y = 6.65%; C/Y = quarterly = 4;
FV = $67,113.46

Step 2: Solve for the periodic interest rate, i.

i = I/Y
C/Y
= 6.65%
4
= 1.6625%
 Step 3: Use the formula for the future value, rearrange, and solve for n.
n
FV = PV(1+i)
n
67,113.46 = 43,000(1 + 0.016625)
n
1.560778 = 1.016625
n
ln(1.560778) = ln(1.016625) (by taking ln of both sides)
n
ln(1.560778) = n ln(1.016625) (by using the property ln (x) = n ln(x))
n = ln(1.560778)
ln(1.016625)
n = 0.445184
0.016488
n = 27 quarterly compounds
Step 4: Convert n to years and months.
Years = n
C/Y
= 27
4
= 6.75 years
= 6 years and .75 X 12 = 9 months

N I/Y P/V F/V P/Y C/Y

Answer:
6.65 -43,000 67,113.46 4 4
26.999996
Thank
You