Quantitative Methods I Flashcards
Real risk free rate
Theoretical rate with no expectation of inflation (i.e. after inflation)
Nominal risk free rate
Real risk free rate + inflation
T-bills, for example, include inflation premium
Required interest rate
nominal risk free rate +
default risk premium +
liquidity premium +
maturity premium
Effective annual rate
(1+periodic rate) ^ (m-1)
I.e. compounding monthly for actual annual rate
Normal annuity
Cash flows occur at the end of each period
Annuity due
Cash flows occur at the beginning of each period
Make sure calc is set to beginning
Perpetuity
Pays fixed amount at set intervals for an infinite (perpetual) period
PV = Payment / rate of return
Amortization table
- Use tmv functions to calculate payments
- Interest = beginning balance * periodic interest rate
- Principal = payment - interest
- Ending balance = beginning - principal
NPV rule
- Accept projects with positive NPV; increase shareholder value
- When two projects are mutually exclusive, accept higher NPV
IRR rule
Accept projects with IRR > required return only
Problems with IRR
- Always accept greatest NPV, when IRR and NPV conflict.
2. IRR assumes reinvestment at the discount rate
Holding period return (HPR or HPY)
(ending value - beginning value + cash received) / beginning value
Bank Discount Yield (BDY)
[(face value - purchase price) / (face value)] * (360 / days until maturity)
Effective Annual Yield (EAY)
(1+HPR)^(365/t)-1
Basic annualization based on 365 year
Money Market Yield (CD Equivalent)
(360 / # of days) * HPY
Doesn’t account for compounding
