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3 visualizzazioni90 pagineNew Ot's famous 6th chapter

Nov 05, 2015

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New Ot's famous 6th chapter

© All Rights Reserved

3 visualizzazioni

New Ot's famous 6th chapter

© All Rights Reserved

- The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
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- I Will Teach You to Be Rich, Second Edition: No Guilt. No Excuses. No BS. Just a 6-Week Program That Works
- The Total Money Makeover Workbook: Classic Edition: The Essential Companion for Applying the Book’s Principles
- Rich Dad Poor Dad
- Clinton Cash: The Untold Story of How and Why Foreign Governments and Businesses Helped Make Bill and Hillary Rich
- The Richest Man in Babylon
- You Need a Budget: The Proven System for Breaking the Paycheck-to-Paycheck Cycle, Getting Out of Debt, and Living the Life You Want
- You Need a Budget: The Proven System for Breaking the Paycheck-to-Paycheck Cycle, Getting Out of Debt, and Living the Life You Want
- Permanent Record
- Buy It, Rent It, Profit!: Make Money As a Landlord in Any Real Estate Market
- Rich Dad's Cashflow Quadrant
- Bad with Money: The Imperfect Art of Getting Your Financial Sh*t Together
- The Borrowers
- The Spider Network: The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History
- The Spider Network: How a Math Genius and a Gang of Scheming Bankers Pulled Off One of the Greatest Scams in History
- The Mandibles: A Family, 2029-2047
- The Mandibles: A Family, 2029-2047
- Personal Finance For Dummies

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Future value

Present value

Annuities

Rates of return

Amortization

6-1

Time lines

0

CF1

CF2

CF3

i%

CF0

Tick marks occur at the end of periods, so

Time 0 is today; Time 1 is the end of the

first period (year, month, etc.) or the

beginning of the second period.

6-2

$100 lump sum due in 2 years;

3-year $100 ordinary annuity

$100 lump sum due in 2 years

0

i%

100

0

100

100

100

i%

6-3

Uneven cash flow stream; CF0 = -$50,

CF1 = $100, CF2 = $75, and CF3 = $50

Uneven cash flow stream

0

100

75

50

i%

-50

6-4

$100 after 3 years, if I/YR = 10%?

cash flows when compound interest is

applied is called compounding.

FV can be solved by using the arithmetic,

financial calculator, and spreadsheet

methods.

10%

100

FV = ?

6-5

The arithmetic method

After 1 year:

FV1 = PV ( 1 + i ) = $100 (1.10)

= $110.00

After 2 years:

2

2

FV2 = PV ( 1 + i ) = $100 (1.10)

=$121.00

After 3 years:

3

3

FV3 = PV ( 1 + i ) = $100 (1.10)

=$133.10

After n years (general case):

n

FVn = PV ( 1 + i )

6-6

The calculator method

Requires 4 inputs into calculator, and will

solve for the fifth. (Set to P/YR = 1 and

END mode.)

INPUTS

OUTPUT

10

-100

I/YR

PV

PMT

FV

133.10

6-7

Extra example

PV = 1000

R = 10%

n=1

FV = ? FV = 1000*(1.10) = 1,100

6-8

Example 2

Compound Interest

PV = 1000

R = 10%

n=3

FV = ?

FV = 1000*(1.1)*(1.1)*(1.1) = 1,331

FV = PV*(1+R)^n

6-9

Example 3:

PV = 1

R = 6%

n = 50

FV = ?

FV = PV*(1+R)^n = 18

n = 100, FV = 339

n = 200, FV = 115,000

6-10

Example 4:

Doubling times

double

FV

2 (1 R)n

PV

log(2) n log(1 R)

log(2)

n

log(1 R)

6-11

Example 5

Retirement Saving

R = 0.05

R = 0.07

FV = PV*(1+0.05)^45 = 8985

Doubling 14

FV=PV*(1+0.07)^45 = 21,002

Doubling = 10

6-12

Retirement Savings at 5%

interest

6-13

Goals

Present Value

Valuing an income stream

Annuities

Perpetuities

Mixed streams

Term structure again

Compounding

More applications

6-14

Example

R = 0.05

PV = 1000/(1.05)^5 = $784

This is the amount that could be

stashed away to give 1000 in 5 years

time

6-15

Goals

Present Value

Valuing an income stream

Annuities

Perpetuities

Mixed streams

Term structure again

Compounding

More applications

6-16

due in 3 years, if I/YR = 10%?

cash flows when compound interest is

applied is called discounting (the reverse of

compounding).

The PV shows the value of cash flows in

terms of todays purchasing power.

10%

PV = ?

100

6-17

The arithmetic method

PV = FVn / ( 1 + i )n

PV = FV3 / ( 1 + i )3

= $100 / ( 1.10 )3

= $75.13

6-18

The calculator method

Exactly like solving for FV, except we

have different input information and are

solving for a different variable.

INPUTS

OUTPUT

10

I/YR

PV

100

PMT

FV

-75.13

6-19

Present Value

Know FV

FV

Get PV

PV

n

(1 R)

tomorrow worth today

6-20

Annuity

Usually annual

6-21

10 years (starting in 1 year)

What is the present value of this?

10

R = 0.05

100

PV

i1

(1 R)

772

6-22

10 years (starting in 1 year)

What is the future value of this at year

10?

9

R = 0.05 FV

100(1.05)i

i0

6-23

Period

Period

Period

Period

10: 100

9: 100(1.05)

8: 100(1.05)(1.05)

1:

100(1.05)^9

Be careful!

6-24

Application: Lotteries

Choices

$33 million over 33 years (1 per year)

R = 7%

33

1

i

(1

0.07)

i1

PV

today

6-25

Annuity

Annuity of $100

Interest = 5%

PV = 100/(1.05) + 100/(1.05)^2 +

100/(1.05)^3

= 272.32

6-26

bundles

One way to generate each of the three $100

payments

How much should each amount be?

100 = FV = PV*(1.05)^n (n = 1, 2, 3)

PV = 100/(1.05)^n (n = 1, 2, 3)

you would have to put into bank accounts

today to generate the annuity

Since this is the same thing as the annuity it

6-27

should have the same price (value)

Solving for N:

If sales grow at 20% per year, how long

before sales double?

Same as previous problems, but now

solving for N.

INPUTS

N

OUTPUT

20

-1

I/YR

PV

PMT

FV

3.8

6-28

ordinary annuity and an annuity due?

Ordinary Annuity

0

i%

PMT

PMT

PMT

PMT

PMT

Annuity Due

0

i%

PMT

6-29

3-year ordinary annuity of $100 at 10%

each period, but there is no PV.

INPUTS

OUTPUT

10

-100

I/YR

PV

PMT

FV

331

6-30

3-year ordinary annuity of $100 at 10%

each period, but now there is no FV.

INPUTS

OUTPUT

10

I/YR

PV

100

PMT

FV

-248.69

6-31

3-year annuity due of $100 at 10%

beginning of each period.

Set calculator to BEGIN mode.

INPUTS

OUTPUT

10

-100

I/YR

PV

PMT

FV

364.10

6-32

3 year annuity due of $100 at 10%

beginning of each period.

Set calculator to BEGIN mode.

INPUTS

OUTPUT

10

I/YR

PV

100

PMT

FV

-273.55

6-33

cash flow stream?

0

100

300

300

-50

10%

90.91

247.93

225.39

-34.15

530.08 = PV

6-34

Uneven cash flow stream

register:

CF0

CF1

CF2

CF3

CF4

=

=

=

=

=

0

100

300

300

-50

NPV = $530.09. (Here NPV = PV.)

6-35

Perpetuity

6-36

Discounting to infinity

Math review:

6-37

Present Value of a

Constant Stream

a

1

1 R

PV

i1

PV y

y

(1 R)i

1

1 R

ai

i1

1

1

a

y

(1 R)

(1 R)

PV

y

(y)

1

1 R

1

1 a

R

1

(1 R)

1 R (1 R)

6-38

Interest Rate Sensitivity

y=100

R = 0.05, PV = 2000

R = 0.03, PV = 3333

6-39

Goals

Present Value

Valuing an income stream

Annuities

Perpetuities

Mixed streams

Term structure again

Compounding

More applications

6-40

Mixed Stream

Apartment Building

Pays $1000 rent 2 years from now

Then sell for 100,000 3 years from now

R = 0.05

500 1000 100000

PV

87, 767

2

3

1.05 (1.05) (1.05)

6-41

Mixed Stream

Investment Project

Then 100 per year for 15 years

R = 0.05

15

100

PV 1000

38

i

(1.05)

i1

Technique = Net present value (NPV)

6-42

Solving for I:

What interest rate would cause $100 to

grow to $125.97 in 3 years?

INPUTS

3

N

OUTPUT

I/YR

-100

125.97

PV

PMT

FV

8

6-43

Interest

A 20-year-old student wants to start saving for

retirement. She plans to save $3 a day. Every

day, she puts $3 in her drawer. At the end of

the year, she invests the accumulated savings

($1,095) in an online stock account. The stock

account has an expected annual return of 12%.

years old?

6-44

Savings problem

her plan, she will have $1,487,261.89

when she is 65.

INPUTS

OUTPUT

45

12

-1095

I/YR

PV

PMT

FV

1,487,262

6-45

Savings problem, if you wait until you are

40 years old to start

today, and sticks to the plan, he or she will

have $146,000.59 at age 65. This is $1.3

million less than if starting at age 20.

Lesson: It pays to start saving early.

INPUTS

OUTPUT

25

12

-1095

I/YR

PV

PMT

FV

146,001

6-46

How much must the 40-year old deposit

annually to catch the 20-year old?

enter the number of years until retirement

and the final goal of $1,487,261.89, and

solve for PMT.

INPUTS

OUTPUT

25

12

I/YR

PV

1,487,262

PMT

FV

-11,154.42

6-47

smaller if compounded more often,

holding the stated I% constant?

occurs, interest is earned on interest more often.

10%

100

133.10

Annually: FV3 = $100(1.10)3 = $133.10

0

0

100

5%

1

2

2

4

3

6

134.01

6-48

state rate. An annual rate that ignores

compounding effects.

given, e.g. 8% Quarterly or 8% Daily interest.

charged each period, e.g. monthly or quarterly.

compounding periods per year. m = 4 for

quarterly and m = 12 for monthly

compounding.

6-49

EFF%) the annual rate of interest actually

being earned, taking into account

compounding.

EFF% = ( 1 + iNOM / m )m - 1

= ( 1 + 0.10 / 2 )2 1 = 10.25%

an investment offering a 10.25% annual

return and one offering a 10% annual

return, compounded semiannually.

6-50

effective rates of return?

different from one with quarterly payments.

Must put each return on an EFF% basis to

compare rates of return. Must use EFF% for

comparisons. See following values of EFF%

rates at various compounding levels.

EARANNUAL

EARQUARTERLY

EARMONTHLY

EARDAILY (365)

10.00%

10.38%

10.47%

10.52%

6-51

equal to the nominal rate?

is used, i.e., if m = 1.

If m > 1, EFF% will always be greater

than the nominal rate.

6-52

banks and brokers. Not used in

calculations or shown on time lines.

iPER Used in calculations and shown on

time lines. If m = 1, iNOM = iPER =

EAR.

EAR Used to compare returns on

investments with different payments

per year. Used in calculations when

annuity payments dont match

compounding periods.

6-53

10% semiannual compounding? Quarterly

compounding?

iNOM mn

FVn PV ( 1

)

m

0.10 23

FV3S $100 ( 1

)

2

6

FV3S $100 (1.05) $134.01

12

6-54

annuity, if the quoted interest rate is

10%, compounded semiannually?

0

1

2

2

4

3

6

5%

100

100

100

occurs every 6 months.

Cannot use normal annuity valuation

techniques.

6-55

Method 1:

Compound each cash flow

0

1

2

2

4

3

6

5%

100

100

100

110.25

121.55

331.80

FV3 = $331.80

6-56

Method 2:

Financial calculator

EAR = ( 1 + 0.10 / 2 )2 1 = 10.25%.

INPUTS

OUTPUT

10.25

-100

I/YR

PV

PMT

FV

331.80

6-57

ordinary annuity.

flow, or

Use the EAR and treat as an annuity to

solve for PV.

INPUTS

OUTPUT

10.25

I/YR

PV

100

PMT

FV

-247.59

6-58

Loan amortization

home mortgages, auto loans, business

loans, retirement plans, etc.

Financial calculators and spreadsheets are

great for setting up amortization tables.

schedule for a $1,000, 10% annual rate

loan with 3 equal payments.

6-59

Step 1:

Find the required annual payment

just remember that the FV = 0 because

the reason for amortizing the loan and

making payments is to retire the loan.

INPUTS

OUTPUT

10

-1000

I/YR

PV

PMT

FV

402.11

6-60

Step 2:

Find the interest paid in Year 1

initial balance at the end of the first

year. Interest to be paid in the first

year can be found by multiplying the

beginning balance by the interest rate.

INTt = Beg balt (i)

INT1 = $1,000 (0.10) = $100

6-61

Step 3:

Find the principal repaid in Year 1

the end of the first year and $100 was

paid toward interest, the remaining

value must represent the amount of

principal repaid.

PRIN = PMT INT

= $402.11 - $100 = $302.11

6-62

Step 4:

Find the ending balance after Year 1

period, subtract the amount paid

toward principal from the beginning

balance.

= $1,000 - $302.11

= $697.89

6-63

Repeat steps 1 4 until end of loan

Year

INT

PRIN

END

BAL

$302

$698

$1,000

$402

$100

698

402

70

332

366

366

402

37

366

1,206.34

206.34

1,000

TOTAL

the balance declines. What are the tax

implications of this?

6-64

Where does the money go?

$

402.11

Interest

302.11

Principal Payments

Constant payments.

Declining interest payments.

Declining balance.

6-65

Partial amortization

to buy a $250,000 home, requiring a

$30,000 down payment.

The home buyer only has $7,500 in cash, so

the seller agrees to take a note with the

following terms:

7.5% nominal interest rate

Payments made at the end of the year, based

upon a 20-year amortization schedule.

Loan matures at the end of the 10th year.

6-66

home buyer must make annual

payments of $2,207.07 on the loan.

INPUTS

OUTPUT

20

7.5

-22500

I/YR

PV

PMT

FV

2207.07

6-67

(spreadsheet or calculator), it can be

found that at the end of the 10th year,

the remaining balance on the loan will

be $15,149.54.

Therefore,

Balloon payment = $15,149.54

Final payment = $17,356.61

6-68

Term Structure

over time

In real life it may be different over

different horizons (maturities)

Remember: Term structure

Use correct R to discount different

horizons

6-69

Term Structure

y1

y2

y3

PV

2

(1 R1 ) (1 R2 ) (1 R3 )3

6-70

Usual quote:

(1+.06/12)^12-1

6.17%

6-71

General Formulas

APR m

EFF (1

) 1

m

EFF e

APR

limit EFF = 0.0618

6-72

Goals

Present Value

Valuing an income stream

Annuities

Perpetuities

Mixed streams

Term structure again

Compounding

More examples

6-73

More Examples

Home mortgage

Car loans

College

Calculating present values

6-74

Home Mortgage

Amortization

Specifications:

$100,000 mortgage

9% interest

3 years (equal payments) pmt

Find pmt

PV(pmt) = $100,000

6-75

Mortgage PV

3

PMT

PV

100000

i

(1.09)

i1

3

1

100000

i

(1.09)

i1

PMT

PMT = 39,504

6-76

Car Loan

Amount = $1,000

1 Year

12%/12=1% per month

PMT?

6-77

Car Loan

12

PMT

PV

1000

i

(1.01)

i1

12

1

1000

i

(1.01)

i1

PMT

= 88.85

PMT

6-78

Total Payment

12*88.85 = 1,066.20

Looks like 6.6% interest

Why?

6-79

month?

Payment = 88.85

Remaining = 1010 88.85 = 921.15

months?

(1+0.01)*921.15 = 930.36

Remaining = 930.36 88.85 = 841.51

6-80

College

1. Compare

PV(wage without college)

3. Replace PV(tuition) with PV(student loan

payments)

Note: Some of these things are hard to

estimate

Second note: Most studies show that the

answer to this question is yes

6-81

Sometimes difficult

Methods

Financial calculator (see book again)

Excel spreadsheets (see book web page)

Java tools (well use these sometimes)

Other software (matlab)

6-82

Summary

Powerful tool

Useful for day to day problems

Loans/mortgages

Retirement

Stock pricing

Bond pricing

6-83

Trick

put in the bank to get a constant

cashflow stream forever?

Formula:

6-8484

Example

you rich uncle is willing to give you a

loan that you never have to pay back.

Instead, you (and all you descendants)

must agree to pay him and his

descendants $10,000/year forever. If

the interest rate is 7%, how much is he

willing to lend you?

85

6-85

Annuity

PV

n1

1 r

n

86

6-8686

Example

at the end of every year for the next 10

years?

rate forever on any deposit made today

87

6-87

Trick

C 1 C

PV

N

r 1 r r

N

C

1

1

r

1 r

88

6-8888

Example

pay)mortgage. Assume that all you can

afford is $10,000 per year, how much can

you afford to borrow at an interest rate of

7%?

89

6-89

Next Lecture

Topics

Bonds

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