Vous êtes sur la page 1sur 49

Level I - Quantitative Methods

Time Value of Money


www.ift.world
Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute.
Reproduced and republished with permission from CFA Institute. All rights reserved.
1

Contents
1.
2.
3.
4.
5.
6.
7.

Introduction
Interest Rates: Interpretation
The Future Value of a Single Cash Flow
The Future Value of a Series of Cash Flows
The Present Value of a Single Cash Flows
The Present Value of a Series of Cash Flows
Solving for Rates, Number of Periods, or Size
of Annuity Payments
www.ift.world

Video Lecture 1
39 minutes

Video Lecture 2
40 minutes

1. Introduction
Time value of money
Interest rates
Present value
Future value

www.ift.world

2. Interest Rates: Interpretation


Interest rates can be interpreted as:
1. Required rate of return
2. Discount rate
3. Opportunity cost
Say you lend $900 today and receive $990 after one year
Required Rate of Return

Discount Rate

www.ift.world

Opportunity Cost

Interest Rates: Investor Perspective


As investors, we can view an interest rate as:
Nominal
Risk-free
Rate

Real risk-free interest rate +


Inflation premium +
Default risk premium +
Liquidity premium +
Maturity premium

www.ift.world

Practice Question 1
Jill Smith wishes to compute the required rate of return. Which of the
following premiums is she least likely to include?
A. Inflation premium
B. Maturity premium
C. Nominal premium
Answer: C
Required rate of return includes inflation premium, maturity premium, default
risk premium, and liquidity premium. There is no such component as a
nominal premium.

www.ift.world

Practice Question 2
Which of the following is least likely true?
A. Discount rate is the rate needed to calculate present value
B. Opportunity cost represents the value an investor forgoes
C. Required rate of return is the maximum rate of return an investor
must receive to accept an investment
Answer: C
Required rate of return is the minimum rate of return an investor must
receive to accept an investment. Therefore, option C is least likely to be the
interpretation of interest rates.

www.ift.world

Practice Question 3
Investments

Maturity
(in years)

Liquidity

Default risk

Interest Rates (%)

High

Low

2.0

Low

Low

2.5

Low

Low

High

Low

3.0

Low

High

4.0

1.

Explain the difference between the interest rates on


Investment A and Investment B.

2.

Estimate the default risk premium.

3.

Calculate upper and lower limits for the interest rate on


Investment C, r.
www.ift.world

3. Future Value of a Single Cash Flow


PV = 100 and r = 10%
What is the FV after one year?
What is the FV after two years?

FVN = PV (1 + r)N

www.ift.world

Practice Question 4
Cyndia Rojers deposits $5 million in her savings account. The account holders are
entitled to a 5% interest. If Cyndia withdraws cash after 2.5 years, how much cash
would she most likely be able to withdraw?

www.ift.world

10

FV Calculation Using a Financial Calculator


Set to floating decimal

Keystrokes

Explanation

Display

[2nd] [FORMAT] [ ENTER ]

Get into format mode

DEC = 9

[2nd] [QUIT]

Return to standard calc mode

You invest $100 today at 10% compounded annually. How


much will you have in 5 years?
Keystrokes

Explanation

Display

[2nd] [QUIT]

Return to standard calc mode

[2nd] [CLR TVM]

Clears TVM Worksheet

5 [N]

Five years/periods

N=5

10 [I/Y]

Set interest rate

I/Y = 10

100 [PV]

Set present value

PV = 100

0 [PMT]

Set payment

PMT = 0

[CPT] [FV]

Compute future value

FV = -161.05

www.ift.world

11

3.1 Frequency of Compounding


You invest 80,000 in a 3-year certificate of deposit. This CD offers a stated
annual interest rate of 10% compounded quarterly. How much will you
have at the end of three years?

www.ift.world

12

Multiple Compounding Periods - Calculator


You invest 80,000 in a 3-year certificate of deposit. This CD offers a stated annual
interest rate of 10% compounded quarterly. How much will you have at the end of
three years?

www.ift.world

13

Practice Question 5
Donald invested $3 million in an American bank that promises to pay 4% compounded daily. Which
of the following is closest to the amount Donald receives at the end of the first year? Assume 365
days in a year.
A. $3.003 million
B. $3.122 million
C. $3.562 million

www.ift.world

14

3.2 Continuous Compounding


Infinite compounding periods per year continuous compounding

FVN = PV e r N
An investment worth $50,000 earns interest that is compounded
continuously. The stated annual interest is 3.6%. What is the
future value of the investment after 3 years?

www.ift.world

15

Concept Building Exercise


Assume the stated annual interest rate is 12%. What is the future value of $100 at
different compounding frequencies?
Frequency

Future value of $100

Return

Annual

112

12.00%

Semiannual

112.36

12.36%

Quarterly
Monthly
Daily
Continuous

www.ift.world

16

3.3 Stated and Effective Rates


With a discrete number of compounding periods:
EAR = (1 + Periodic interest rate)m 1

With continuous compounding:


EAR = er 1

www.ift.world

17

4. The Future Value of a Series of Cash Flows


Annuity: finite set of level sequential cash flows
Ordinary annuity: an annuity where the first cash flow occurs one period from today

Annuity due: an annuity where the first cash flow occurs immediately

Perpetuity: set of level never-ending sequential cash flows with the first cash flow
occurring one period from today
www.ift.world

18

4.1 Future Cash Flows Ordinary Annuity


Ordinary annuity with A = 1,000 r = 5% and N = 5

www.ift.world

19

Ordinary Annuity - Formula


Ordinary annuity with A = 1,000 r = 5% and N = 5

FVN = A {[(1+r)N 1]/r}


FVN = A {Future Value Annuity Factor}

www.ift.world

20

Ordinary Annuity - Calculator


Ordinary annuity with A = 1,000 r = 5% and N = 5

N=5
I/Y = 5
PV = 0
PMT = 1,000
CPT

FV

www.ift.world

21

Practice Question 6
Haley deposits $24,000 in her bank account at the end of every year. The account
earns 12% per annum. If she continues this practice, how much money will she have
at the end of 15 years?

www.ift.world

22

Practice Question 7
Iago wishes to compute the future value of an annuity worth $120,000. He is aware
that the FV annuity factor is 21.664 and the interest rate is 4.5%. Which of the
following is least likely to be useful for the future value computation?
A. Annuity worth
B. Future value annuity factor
C. Interest rate

Answer: C

www.ift.world

23

4.2 Unequal Cash Flows


Time

Cash Flow ($)

1,000

2,000

3,000

4,000

5,000

What is the future value at year 5?

www.ift.world

24

End of Lecture 1

www.ift.world

25

5. Finding the Present Value of a Single Cash Flow


PV = FVN (1+r)-N

For a given discount rate, the farther in the future the amount to be received,
the small the amounts present value.
Holding time constant, the larger the discount rate, the smaller the present
value of a future amount.

www.ift.world

26

Practice Question 8
Liam purchases a contract from an insurance company. The contract promises to pay
$600,000 after 8 years with a 5% return. What amount of money should Liam most
likely invest? Solve using the formula and TVM functions on the calculator.

Answer: 406,104

www.ift.world

27

Practice Question 9
Mathews wishes to fund his son, Nathans, college tuition fee. He purchases a security
that will pay $1,000,000 in 12 years. Nathans college begins 3 years from now. Given
that the discount rate is 7.5%, what is the securitys value at the time of Nathans
admission?

Answer: 521,583

www.ift.world

28

Practice Question 10
Orlando is a manager at an Australian pension fund. 5 years from today he wants a
lump sum amount of AUD40, 000. Given that the current interest rate is 4% a year,
compounded monthly, how much should Orlando invest today?

Answer: 32,760

www.ift.world

29

6. Present Value of a Series of Cash Flows


Present value of a series of equal cash flows (annuity)
Present value of a perpetuity
Present value indexed at times other than zero
Present value of a series of unequal cash flows

www.ift.world

30

6.1 Present Value of a Series of Equal Cash Flows


Ordinary annuity with A = 10 r = 5% and N = 5
0

www.ift.world

31

PV of an Ordinary Annuity: Using the Formula


Ordinary annuity with A = 10 r = 5% and N = 5
0

PV = A {[1 1/(1+r)N]/r}

www.ift.world

32

PV of an Ordinary Annuity: Using the Calculator


Ordinary annuity with A = 10 r = 5% and N = 5
0

www.ift.world

33

Annuity Due The Concept


Annuity due with A = 10 r = 5% and N = 5
0

www.ift.world

34

PV of an Annuity Due: Using the Formula


Annuity due with A = 10 r = 5% and N = 5
0

PV (annuity due) = A {[1 1/(1+r)N]/r} (1+r)

www.ift.world

35

PV of an Annuity Due: Using the Calculator


Annuity due with A = 10 r = 5% and N = 5
0

www.ift.world

Key Strokes

Display

[2nd] [BGN] [2nd] [SET]

BGN

[2nd] [QUIT]

BGN

[2nd] [CLR TVM]

BGN

5 [N]

BGN

N=5

5 [I/Y]

BGN

I/Y = 5

10 [PMT]

BGN

PMT = 10

0 [FV]

BGN

FV = 0

[CPT] [PV]

BGN

[2nd] [BGN] [2nd] [SET]

END

[2nd] [QUIT]

36

6.2 Present Value of a Perpetuity


PV = A/r
Present value is one period before the first
cash flow
Simple example to understand the formula:
You invest $100 and get 5% for ever. What is
the cash flow?

www.ift.world

37

6.3 Present Values Indexed at Times Other Than t=0


An annuity or perpetuity beginning sometime in the future can be expressed in present
value terms one period prior to the first payment

Discount back to todays present value

www.ift.world

38

Practice Question 11
Bill Graham is willing to pay for a perpetual preferred stock that pays dividends worth
$100 per year indefinitely. The first payment will be received at t = 4. Given that the
required rate of return is 10%, how much should Mr. Graham pay today?

Answer: 751.31

www.ift.world

39

6.4 The Present Value of a Series of Unequal Cash Flows


Find the present value of each individual cash
Sum the respective present values

www.ift.world

40

Practice Question 12
Andy makes an investment with the expected cash flow shown in the table below.
Assuming a discount rate of 9% what is the present value of this investment?
Time Period
1
2
3
4
5

Cash Flow($)
50
100
150
200
250

Answer: 550

www.ift.world

41

7. Solving for Rates, Number of Periods, or Size of


Annuity Payments

Solving for Interest Rates and Growth


Solving for Number of Periods
Solving for the Size of Annuity Payments
Review of Present Value and Future Value Equivalence
The Cash Flow Additivity Principle

www.ift.world

42

7.1 Solving for Interest Rates and Growth Rates


A $100 deposit today grows to $121 in 2 years.
What is the interest rate? Use both the formula and the
calculator method.
The population of a small town is 100,000 on 1 Jan
2000. On 31 December 2001 the population is
121,000. What is the growth rate?

You invest $900 today and receive a $100 coupon


payment at the end of every year for 5 years. In
addition, you receive $1,000 and the end of year 5.
What is the interest rate?
www.ift.world

43

7.2 Solving for the Number of Periods


You invest $2,500. How many years will it take to triple the amount given that
the interest rate is 6% per annum compounded annually? Use both the formula
and the calculator method.

Answer: 18.85 years


www.ift.world

44

7.3 Solving for the Size of Annuity Payments


Freddie bought a car worth $42,000 today. He was required to make a 15% down payment. The
remainder was to be paid as a monthly payment over the next 12 months with the first payment
due at t=1. Given that the interest rate is 8% per annum compounded monthly, what is the
approximate monthly payment?

Answer: 3,106

www.ift.world

45

7.4 Review of Present and Future Value Equivalence


Ordinary annuity with A = 10 r = 5% and N = 5 PV = 43.29
A lump sum can be considered equivalent
to an annuity

Lump sum = PV = 43.29


An annuity can be considered equivalent
to a future value
FV = 55.26
A lump sum can be considered equivalent
to a future value

www.ift.world

46

7.5 The Cash Flow Additivity Principle


Amounts of money indexed at the same point in time are additive

www.ift.world

47

Summary
1. Interest Rates
2. Future Value
3. Present Value
4. Solving for Rates, Number of
Periods, or Size of Annuity
Payments
www.ift.world

48

Conclusion
Review learning objectives
Examples and practice problems from the
curriculum
Practice questions from other sources

www.ift.world

49