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Lecture2. Time value of money.docx

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Administrative Studies
ADMS 3530
Irvin Pestano

Chapter 4. Time value of money Process of calculating future values is compounding, while process of calculating present value is discounting. Multiple cash flows- Annuity, perpetuaty...etc. Problem 1. You want to buy a computer , there are two payment options: i. Pay $800 today, or ii. Pay $1000 one year from today. 0------------------------------------------------1 800 1000 Interest is $200, i.e. @ 25% A dollar today is worth $1.25 a year from now ( 1000/800) A dollar in future is worth 800/1000= 80cents. Simple Interest: Interest is only earned on the investment Compound Interest: Interest is reinvested and therefore interest is earned on the interest and the principle. FV= PV( FVIF r, t) FVIF Future value interest factor FV= PV( 1 +r)^t For greater returns, we should invest it at higher interest rate as well as for longer period of time. How long would it take for money to double: n= 72/r PV= FV ( PVIF r, t) Present value interest factor PV= FV/ (1+r)^t Zero coupon bonds i. Pays no interest ii. Pays face value (assumption $1000) How much would you pay for a zero coupon bond which matures in 12 years ? you require a return of 13.26%. The pres
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