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Financial Mathematics: Valuation & Investment

The document discusses financial mathematics concepts including present and future values using arithmetic and geometric progressions, as well as annuities for loan amortization and sinking funds. It also covers decision-making in capital investment through Net Present Value (NPV) and Internal Rate of Return (IRR) criteria. Key formulas and relationships for calculating future values and annuities are provided.

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Syenny Ng
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8 views4 pages

Financial Mathematics: Valuation & Investment

The document discusses financial mathematics concepts including present and future values using arithmetic and geometric progressions, as well as annuities for loan amortization and sinking funds. It also covers decision-making in capital investment through Net Present Value (NPV) and Internal Rate of Return (IRR) criteria. Key formulas and relationships for calculating future values and annuities are provided.

Uploaded by

Syenny Ng
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

FINANCIAL MATHEMATICS

1. Individual present and future values

time
Future value
Present value Arithmetic progression → Nominal / simple
𝑭𝑽 = 𝑺𝒏
𝟏 interest (r)
𝑷𝑽 = 𝑺𝒏 ( ) = 𝑷𝑽(𝟏 + 𝒓𝒏)
𝟏 + 𝒓𝒏
𝑺𝒏
=
(𝟏 + 𝒓𝒏)

Present value Future value


Geometric progression → Compound interest (i)
𝟏 𝑭𝑽 = 𝑺𝒏
𝑷𝑽 = 𝑺𝒏 ( )
(𝟏 + 𝒊)𝒏
𝑺𝒏 = 𝑷𝑽(𝟏 + 𝒊)𝒏
=
(𝟏 + 𝒊)𝒏

2. Annuity
→ Ordinary annuity → to amortize loan or debt (principle) (Unpaid balance (Principle + Total
interest (FV)) = Paid balance (FVOA)) → making loan amortization
schedule
𝑺𝒏
𝑷𝑽 = → to obtain the amount of fund in the future (S = paid balance (FVOA))
(𝟏 + 𝒊)𝒏
→ making sinking fund schedule
FVOA= 𝑪𝟏 (𝟏 + 𝒊)𝒏−𝟏 + 𝑪𝟐 (𝟏 + 𝒊)𝒏−𝟐 + 𝑪𝟑 (𝟏 + 𝒊)𝒏−𝟑 + ⋯ + 𝑪𝒏 (𝟏 + 𝒊)𝟎 ,
where 𝐶1 = 𝐶2 = 𝐶3 = ⋯ = 𝐶𝑛 = C→ paid balance at the end of time interval within the whole
period.
(𝟏+𝒊)𝒏−𝟏
S = 𝑪[ ]
𝒊

→ Annuity due
FVAD = 𝑪𝟏 (𝟏 + 𝒊)𝒏 + 𝑪𝟐 (𝟏 + 𝒊)𝒏−𝟏 + 𝑪𝟑 (𝟏 + 𝒊)𝒏−𝟐 + ⋯ + 𝑪𝒏 (𝟏 + 𝒊)𝟏 ,
where 𝐶1 = 𝐶2 = 𝐶3 = ⋯ = 𝐶𝑛 → paid balance at the beginning of time interval within the
whole period.
(𝟏+𝒊)𝒏−𝟏
= 𝑪(𝟏 + 𝒊) [ ]
𝒊

FVAD > FVOA

3. Decision making on the capital / project investment


→NPV

NPV > 0 → Accept the project


NPV = 0 → Accept the project → IRR > Cost of capital (rate)
→ Reject the project → IRR < Cost of capital (rate)
NPV < 0→ Reject the project
→ IRR

NPV
NPV1 A = (r1, NPV1)

B = (IRR, 0)
r
0 r1 r2

NPV2 C = (r2, NPV2)

Slope from A to B = Slope from B to C


(0 − 𝑁𝑃𝑉1) (𝑁𝑃𝑉2 − 0)
=
(𝐼𝑅𝑅 − 𝑟1) (𝑟2 − 𝐼𝑅𝑅)
(𝑁𝑃𝑉1)
𝐼𝑅𝑅 = 𝑟1 + (𝑟2 − 𝑟1)
(𝑁𝑃𝑉1 − 𝑁𝑃𝑉2)

0 𝑦𝑒𝑎𝑟 = 100
1 year = 100 + (100(0.10)) = 100(1 + (0.10))

2 year = 100(1 + (0.10)) + (100(1 + (0.10)))(0.10)

= (100 + 100(0.10)) + (100 + 100(10.10)2 )

= 100(1 + 0.10)2

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