Foundations of Finance A Complete Lecture Notes

Wednesday, 25 January 2017

Foundations of Finance Lecture Notes

Lectures 1 & 2 - Time Value of Money and Interest Rates

Time Value of Money
What is the value of an investment made today at a specific future date? (Future Value)

What is the value today (Present Value) of a cash flow to be received at a specific date
in the future?

• Inflows are denoted by positive numbers, outflows are denoted by negative
numbers

• Cash flows can be presented on annual, semi-annual, monthly basis


Rules of Time Travel

Basic concept: £1 Today is worth more than £1 tomorrow (impatience, inflation etc.)

1) Comparing and Combining Values

• It is only possible to compare and combine (add and subtract) values at the same
point in time

2) Moving Cash Flows Forward in Time

• To move a cash flow forward in time you must compound it (at an appropriate rate)
• FVn = C0 (1+ r)n
3) Moving Cash Flows Back in Time

• To move a cash flow back in time you must discount it
• PV0 = Cn / (1+ r)n




1

, Wednesday, 25 January 2017
Compounding Values




2

, Wednesday, 25 January 2017
Discounting Values




3

, Wednesday, 25 January 2017
Perpetuities

A perpetuity is a stream of equal cash flows that occur at regular intervals and last
forever



Given in formula book

Logic:

• Invest C / r today
• Grows to C / r(1+r) = C / r + C next period
• Withdraw C and reinvent C / r
- Constant cash flow C forever
- Cost of Initial investment (PV) = C / r


Annuities

An annuity is a stream of N equal cash flows paid at regular intervals (fixed number of
payments)

Logic:

• The same concept but after N periods, investment is closed and you withdraw initial
investment P




4