Exam 1 (Ch 1,2,3,4,5,6,7,11,12,18) Flashcards
3 ways of calculating PV of a single cash flow
Excels PV function
Present Value Formula
Timeline
What makes the future value of a single cash flow increase
if you increase:
pv
discount rate
number of periods
Explain the formula for calculating the future value of each cash flow
each cash flow is compounded at the discount rate for the remaining periods
FV=C0 * (1+r)n
Present Value Interest Factor for an Annuity
The formula to calculate PVIFA is (1 - (1 + r)^-n) / r, where r represents the period rate, and n represents the number of payments or withdrawals.
APV = PMT X PVIFA.
Annuity Future Value
the value of a group of recurring payments at a certain date in the future, assuming a particular rate of return, or discount rate.
AFV=APV*(1+r)^t
Affect on Aunnity Present Value
decrease payment amount = decrease in APV bc a smaller investment means smaller cash flow
decrease discount rate = increase in APV
Can a constant discount rate formula be used when the discount rate changes over time>
No, the formula doesn’t account for changes in the rate
How do you use the NPV function in excel
NPV is calculated by subtracting the initial investment from the PV
Positive NPV Means…
A project should be accepted
nominal discount rate
real interest rate plus the projected rate of inflation
= (1+i)*(1+r)-1
why cant you just add real rate and interest to get nominal rate?
We will miss the cross-product term i (r), which is the increase in the real discount rate due to
inflation.
can the general discount rate method be used when the rate is the same
yes, same rate is entered each year
why is the demoninator not raised to t in the general discount rate formula
the cumulative rate already accounted for the # of periods since it is compounded
Can excels NPV function be used when there’s multiple rates
No
5 components of the return on equity in the Du Pont System of ratio analysis
tax burden
interest burden
operating profit margin
total asset turnover
equity multiplier
What increases tax burden
paying less taxes because net profit will be higher
What decreases interest burden
if a company pays more interest relative to EBIT
Bond Price
PV of interest payments + PV of face value
What makes a bond sell at discount
if the coupon rate is less than the yield to maturity
Four ways of calulating Bond Price
PV of cashflows using timeline
formula for bond price
excels pv function
excels PRICE function
Bond price results using APR vs EAR
Apr convention results in higher discount rate because of simple interest = Lower bond price
EAR convention results in a lower discount rate due to compound interest = high bond price
bond pricing works backwards from face value and coupon payments
Relationship between bond price and yield to maturity
The bond price decreases at a decreasing rate as yield to maturity increases because the opportunity
cost (risk) increases.
State and explain the effect of a higher coupon rate on a bond’s price.
The bond price increases because the coupon payments increase, raising the present value of cash
flows.
Ordinary annuity
a series of regular payments made at the end of each period, such as monthly or quarterly.
Annuity due
an annuity whose payment is due immediately at the beginning of each period.
Treasury STRIPS
U.S. bonds that are sold at a discount to their face value and pay full face value at their maturity.
STRIPS are treasury bonds where the principal and coupon payments trade as separate securities. STRIPS holders do not receive coupon payments, only the final payoff on the date of maturity.
YearFrac Function
the fractional years between two calendar dates
yield
the measure of return, as a percentage - interest rates
yield curve
line that depicts different bond yields with varying maturity dates
Upward Sloping Yield Curve/positive
Most normal
as maturity increases so does the yield
downward sloping yied curve/ inverted
as maturity increases the yield decreases
Flat Yield
as maturity increases yield remains the same
hump shaped yield
when medium-term rates are higher than short and long-term rates
what do yield curves tell you?
normal curve - economic expansion
inverted - economic recession
Static features for level of yield curve
high or low
Static feature for curvature
lot or little
