Math for Finance
simple interest vs compound interest
simple: interest on principle
compound: interest on principle plus accumulated interest
simple interest = principle * interest rate
compound interest = interest rate * (principle + acc. interes)
time value of money (TVM)
a dollar today is worth more than a dollar in the future, because of potential earnings (and the opportunity cost of waiting)
FV using simple interest
FV = PV * ( 1 + i * n )
FV using compound interest
FV = PV * ( 1 + i/f ) ^ n*f
nominal rate vs effective rate
nominal: no compounding
effective: compounding
annuity factor
sum(DFs)
PV = annuity * annuity factor
arithmetic returns
= (ending price - starting price) / starting price
to be used when prices are unrelated
logarithmic (log) returns
= ln ( ending price / starting price )
to be used when prices are related
What is the IRR and how can we use it?
Internal rate of return (IRR) is achieved when the discount rate gives an NPV of exactly zero.
if IRR > WACC, invest.
if IRR < WACC, return capital.
excel functions for annuities and bonds
=PMT() for annuity calculation
=PV() for bond pricing
=RATE() for YTM calculation