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CASH FLOW VALUATIONS Means that at the end of every time period the cash flow level or cash flow amount is different. Example: An investment returns 10000 after first year, 13000, 15000 & 18000 after 2nd to 4th year respectively. If the prevailing interest is 10% what is the present value of cash flow. Equations: FV = PV x (1 + r)t PV = FV / (1 + r)t YEAR 1 CASH FLOW 10000 FVIF @ PV= 10% Cash Flow / FVIF =1.10 9,090.91 2 13000 =1.21 10,743.80 3 15000 =1.331 11,269.72 4 18000 =1.4641 12,294.24 TOTAL 56000 43,398.68 Effective Annual Rate – EAR EAR basically depend on Compounding More period of Compounding total interest will be more Effective Annual Rate – EA Example: Bank A pays 15% interest on deposit, that is compounded monthly. Bank B pays 15% interest on deposit, which is compounded quarterly. Bank C pays 15% interest on deposit, which is compounded half yearly. Formula to find EAR Bank A (Monthly Compounding) EAR = 1 + i/n n -1 Bank A = 1 + .15/12 12 =1.16075 – 1 = 16.075% -1 • Bank B (Quarterly Compounding) 4 Bank B = 1 + .15/4 - 1 =(1.0375) 4 – 1 = 1.15865 – 1 = 15.865% Bank C (Half Yearly Compounding) Bank C = (1 + .15/2) 2 - 1 = (1.075) 2 - 1 = 1.155625 – 1 = 15.5625% Example: A bank offers 12% compounded quarterly. If you place 1000 in an account today, how much you have at the end of two years? What is EAR (Effective Rate of Interest)? Solution: EAR =(1 + i/n) n -1 EAR = (1 + .12/4)4 – 1= 12.55% = (1.1255)2 X 1000 = 1266.75 OR Quarterly interest is 12/4 = 3% =(1.03)8 X 1000 = 1.2667 X 1000 =1266.77 BOND VALUATION • It’s a debt security • Whenever Company needs Capital, different sources to raise Capital IPO’s of Shares in Primary Market Bank Loan Bond Debt Financing (Different from bank loan) • Bonds have maturity date • Normally Bonds are Long Term like 10 years, 20 years & 30 years Main Characteristics: – How much Interest will be paid? – How many times? – Maturity Terminologies: • Coupon Payments: stated annual interest amount e.g. A Bond which pays Rs. 100 every year. So Coupon payment i.e. Rs. 100 per year. • Coupon Rate: • Coupon Interest Rate = Coupon Payment / Bond’s face value • Face value: Also Par value, shows the nomination value. • Maturity Date: date on which Companies pay back the principal Investment. • Discount Bond: A bond which is sold less than the face or par value is discount bond. Also called Zero Coupon Or Zeros. • Premium Bond: A bond which has a price over and above its face value or its par value is Premium Bond. • Yield to Maturity (YTM): Interest rate required in market on a bond. Or • A Market phenomenon, Interest rate on particular Investment • Current yield: Annual coupon payment(s) divided by bond market price.