Week 1 Flashcards
What does FVF stand for? When do you use it?
It stands for future value factors. We use it to determine the equivalent value at the end of n periods of a sum available now.
What does FVAF stand for? When do you use it?
It stands for future value annuity factors. It again finds the value after n periods however here we have a series of constant cash flows arriving at the end of each year from 0 to n.
What is the constant cash flow? What is V_n? Give a formula relating them.
C is the amount of money you receive each year. For instance, constant £500 per year means C = 500. V_n is the value at time n in the future. C = V_n/FVAF.
What is NTV? What is NCF?
NTV is net terminal value. This is the balance of the NCFs at the end of the period, i.e. is there extra money. The NCF is the net cash flow - basically at each period how much money you have from all sources from this period.
What is an annuity?
it is a constant periodic NCF. I.e. the same amount of money every period for a set number of periods.
What is the formula for FVAF?
It is (1+r)^{n-1} + (1+r)^{n-2} + … + 1. More nicely, it is ((1+r)^n - 1)/r
What is FV? How do we calculate it using FVAF?
It is the future value. We simply multiply the amount we invest each year (the annuity) by the FVAF value, calculated from (…)
What is PV or the discount factor?
It is 1/(1+r)^n. It basically cancels out the effect interest will have. So we can find the value of money in the future in today’s money.
What is r?
It is the discount rate. It might not be the interest rate, it is just some decaying rate.
What is PFV? How do we use it?
1/(1+r)^n. It is the present value factor. We use it to find the value of money today. We have:
V_0 = PVF * V_n, where V_0 is the value today.
What is NPV? What is the formula? When do we use it?
It is the net present value of an investment. It is the leftover money from an investment, measured in today’s values. This is after accounting for cost of capital and interest charges.
The formula is -I_0 + C_1(1/1+r) + C+2 (1/(1+r)^2) + …
Use it when we invest different amounts each period.
What is PVAF? What is the formula? How do we use it?
It is the present value annuity factor. It is given by (1- (1/(1+r)^n)/r
We simply multiple this value by the amount of money we will receive at each period. so PVAF*Annuity, this gives us the present value of the investment.
What is the internal rate of return (IRR)?
It is the rate of discount in which the NPV is equal to zero. I.e. the highest interest rate that can be paid on a loan without making a loss. I.e.
0 = -I_0 + C_1(1/1+r) + C+2 (1/(1+r)^2) + …
What is I_0? What is C_0?
I_0 is the costs really. So if there is an investment needed, it is I_0. C_i is the cash flow in period i, so for instance loans or NCFs will give these C_i’s a value.
What are the two characteristics of a bond? What is a ZCB?
The face value is how much the issuer pays. And the coupon rate of interest (r_c) is the periodic interest payment on the bond. A ZCB is a zero coupon bond, i.e. no interest payments.
