BAII Plus Professional Tutorial

Part I

The TI BAII Plus Professional is a fairly easy to use financial calculator that will serve you well in all
finance courses. This tutorial will demonstrate how to use the financial functions to handle time value
of money problems and make financial math easy. I will keep the examples rather elementary, but
understanding the basics is all that is necessary to learn the calculator.
Initial Setup
Unlike other financial calculators, the BAII Plus Professional comes from the factory set to assume
annual compounding (others default to monthly compounding which is less than optimal). That's
exactly what I have been wanting for years. Why? Well, the compounding assumption is hidden
from view and in my experience people tend to forget to set it to the correct assumption. Of course,
most people don't recognize a wrong answer when they get one, so they blithely forge ahead. If you
ever wish to change the compounding assumption (which I don't recommend), press 2nd I/Y and
enter the number of periods per year (12 for monthly, 2 for semiannual, etc). Now press Enter and
then 2nd CPT (Quit) to return to a blank screen.
One adjustment is important. By default the BAII Plus Professional displays only two decimal
places. This is not enough. Personally, I like to see five decimal places, but you may prefer some
other number. To change the display, press 2nd . , and, when prompted, enter the number of digits
you would like to see displayed. You may have to use the arrow keys to scroll through the list of
options until you see DEC = 2 (or whatever the current number is). Once you set the number of
decimal places, press Enter to lock in your choice. I would press 2nd. 5 Enter 2nd CPT (Quit) to
display 5 decimal places. That's it, the calculator is ready to go.
If you don't find the answer that you are looking for, please check the FAQ. If it isn't there,
please drop me a note and I'll try to answer the question.
Example 1 - Future Value of Lump Sums
We'll begin with a very simple problem that will provide you with most of the skills to perform financial
math on the BAII Plus Professional:
Suppose that you have $100 to invest for a period of 5 years at an interest rate of 10% per
year. How much will you have accumulated at the end of this time period?
In this problem, the $100 is the present value (PV), there are 5 periods (N), and the interest rate is
10% (I/Y). Before entering the data you need to make sure that the financial registers (each key is
nothing more than a memory register, and you can recall the values with the RCL key) are
clear. Otherwise, you may find that numbers left over from previous problems will interfere with the
solution to this one. Press 2nd FV (CLR TVM) to clear the memory. Now all we need to do is enter
the numbers into the appropriate keys: 5 into N , 10 into I/Y , -100 into PV . Now to find the future
value simply press CPT (compute) and then the FV key. The answer you get should be 161.05.
A Couple of Notes
1. Every time value of money problem has either 4 or 5 variables (corresponding to the 5 basic
financial keys). Of these, you will always be given 3 or 4 and asked to solve for the other. In
this case, we have a 4-variable problem and were given 3 of them (N, I/Y, and PV) and had to
solve for the 4th (FV). To solve these problems you simply enter the variables that you know in
the appropriate keys and then press CPT and then the other key to get the answer.
2. The order in which the numbers are entered does not matter.
3. When we entered the interest rate, we input 10 rather than 0.10. This is because the calculator
automatically divides any number entered into the I/Y key by 100. Had you entered 0.10, the
future value would have come out to 100.501 obviously incorrect.
4. Notice that we entered the 100 in PV as a negative number. This was on purpose. Most
financial calculators (and spreadsheets) follow the Cash Flow Sign Convention. This is simply
a way of keeping the direction of the cash flow straight. Cash inflows are entered as positive
numbers and cash outflows are entered as negative numbers. In this problem, the $100 was
an investment (i.e., a cash outflow) and the future value of $161.05 would be a cash inflow in
five years. Had you entered the $100 as a positive number no harm would have been done,
but the answer would have been returned as a negative number. This would be correct had
you borrowed $100 today (cash inflow) and agreed to repay $161.05 (cash outflow) in five
years. Do not change the sign of a number using the - (the "minus" key). Instead, use the + |
- key.
5. We can change any of the variables in this problem without needing to re-enter all of the
data. For example, suppose that we wanted to find out the future value if we left the money
invested for 10 years instead of 5. Simply enter 10 into N and then press CPT FV . You'll find
that the answer is 259.37.
Example 1.1 Present Value of Lump Sums
Solving for the present value of a lump sum is nearly identical to solving for the future value. One
important thing to remember is that the present value will always (unless the interest rate is
negative) be less than the future value. Keep that in mind because it can help you to spot incorrect
answers due to a wrong input. Let's try a new problem:
Suppose that you are planning to send your daughter to college in 18 years. Furthermore, assume
that you have determined that you will need $100,000 at that time in order to pay for tuition, room
and board, party supplies, etc. If you believe that you can earn an average annual rate of return of
8% per year, how much money would you need to invest today as a lump sum to achieve your goal?
In this case, we already know the future value ($100,000), the number of periods (18 years), and the
per period interest rate (8% per year). We want to find the present value. Enter the data as follows:
18 into N , 8 into I/Y , and 100,000 into FV . Note that we enter the $100,000 as a positive number
because you will be withdrawing that amount in 18 years (it will be a cash inflow). Now
press CPT PV and you will see that you need to invest $25,024.90 today in order to meet your goal.
That is a lot of money to invest all at once, but we'll see on the next page that you can lessen the
pain by investing smaller amounts each year.
Example 1.2 Solving for the Number of Periods
Sometimes you know how much money you have now, and how much you need to have at an
undetermined future time period. If you know the interest rate, then we can solve for the amount of
time that it will take for the present value to grow to the future value by solving for N.
Suppose that you have $1,250 today and you would like to know how long it will take you double
your money to $2,500. Assume that you can earn 9% per year on your investment.
This is the classic type of problem that we can quickly approximate using the Rule of 72. However,
we can easily find the exact answer using the BAII Plus calculator. Enter 9 into I/Y , -1250 into PV ,
and 2500 into FV . Now press CPT N and you will see that it will take 8.04 years for your money to
double.
One important thing to note is that you absolutely must enter your numbers according to the cash
flow sign convention. If you don't make either the PV or FV a negative number (and the other one
positive), then you will get Error 5 on the screen instead of the answer. That is because, if both
numbers are positive, the calculator thinks that you are getting a benefit without making any
investment. If you get this error, just press CE\C to clear it and then fix the problem by changing the
sign of either PV or FV.
Example 1.3 Solving for the Interest Rate
Solving for the interest rate is quite common. Maybe you have recently sold an investment and
would like to know what your compound average annual rate of return was. Or, perhaps you are
thinking of making an investment and you would like to know what rate of return you need to earn to
reach a certain future value. Let's return to our college savings problem from above, but we'll change
it slightly.
Suppose that you are planning to send your daughter to college in 18 years. Furthermore, assume
that you have determined that you will need $100,000 at that time in order to pay for tuition, room
and board, party supplies, etc. If you have $20,000 to invest today, what compound average annual
rate of return do you need to earn in order to reach your goal?
As before, we need to be careful when entering the PV and FV into the calculator. In this case, you
are going to invest $20,000 today (a cash outflow) and receive $100,000 in 18 years (a cash inflow).
Therefore, we will enter -20,000 into PV , and 100,000 into FV . Type 18 into N , and then
press CPT I/Y to find that you need to earn an average of 9.35% per year. Again, if you get Error 5
instead of an answer, it is because you didn't follow the cash flow sign convention.
Note that in our original problem we assumed that you would earn 8% per year, and found that you
would need to invest about $25,000 to achieve your goal. In this case, though, we assumed that you
started with only $20,000. Therefore, in order to reach the same goal, you would need to earn a
higher interest rate.
When you have solved a problem, always be sure to give the answer a second look and be sure that
it seems likely to be correct. This requires that you understand the calculations that the calculator is
doing and the relationships between the variables. If you don't, you will quickly learn that if you enter
wrong numbers you will get wrong answers. Remember, the calculator only knows what you tell it, it
doesn't know what you really meant.
Please continue on to part II of this tutorial to learn about using the BAII Plus Professional to solve
problems involving annuities and perpetuities.


BAII Plus Professional Tutorial
Part II

In the previous section we looked at the basic time value of money keys and how to use them to
calculate present and future value of lump sums. In this section we will take a look at how to use the
BAII Plus to calculate the present and future values of regular annuities and annuities due.
A regular annuity is a series of equal cash flows occurring at equally spaced time periods. In a
regular annuity, the first cash flow occurs at the end of the first period.
An annuity due is similar to a regular annuity, except that the first cash flow occurs immediately (at
period 0).
Example 2 Present Value of Annuities
Suppose that you are offered an investment which will pay you $1,000 per year for 10 years. If you
can earn a rate of 9% per year on similar investments, how much should you be willing to pay for
this annuity?
In this case we need to solve for the present value of this annuity since that is the amount that you
would be willing to pay today. Press 2ndFV to clear the financial keys. Enter the numbers into the
appropriate keys: 10 into N , 9 into I/Y , and 1000 (a cash inflow) into PMT . Now press CPT PV to
solve for the present value. The answer is -6,417.6577. Again, this is negative because it
represents the amount you would have to pay (cash outflow) today to purchase this annuity.
Example 2.1 Future Value of Annuities
Now, suppose that you will be borrowing $1000 each year for 10 years at a rate of 9%, and then
paying back the loan immediate after receiving the last payment. How much would you have to
repay? All we need to do is to put a 0 into PV to clear it out, and then press CPT FV to find that the
answer is -15,192.92972 (a cash outflow).
Example 2.2 Solving for the Payment Amount
We often need to solve for annuity payments. For example, you might want to know how much a
mortgage or auto loan payment will be. Or, maybe you want to know how much you will need to
save each year in order to reach a particular goal (saving for college or retirement perhaps). On
the previous page, we looked at an example about saving for college. Let's look at that problem
again, but this time we'll treat it as an annuity problem instead of a lump sum:
Suppose that you are planning to send your daughter to college in 18 years. Furthermore, assume
that you have determined that you will need $100,000 at that time in order to pay for tuition, room
and board, party supplies, etc. If you believe that you can earn an average annual rate of return of
8% per year, how much money would you need to invest at the end of each year to achieve your
goal?
Recall that we previously determined that if you were to make a lump sum investment today, you
would have to invest $25,024.90. That is quite a chunk of change. In this case, saving for college will
be easier because we are going to spread the investment over 18 years, rather than all at once.
(Note that, for now, we are assuming that the first investment will be made one year from now. In
other words, it is a regular annuity.)
Let's enter the data: Type 18 into N , 8 into I/Y , and 100,000 into FV . Now, press CPT PMT and you
will find that you need to invest $2,670.21 per year for the next 18 years to meet your goal of having
$100,000.
Example 2.3 Solving for the Number of Periods
Solving for N answers the question, "How long will it take..." Let's look at an example:
Imagine that you have just retired, and that you have a nest egg of $1,000,000. This is the amount
that you will be drawing down for the rest of your life. If you expect to earn 6% per year on average
and withdraw $70,000 per year, how long will it take to burn through your nest egg (in other words,
for how long can you afford to live)? Assume that your first withdrawal will occur one year from today
(End Mode).
Enter the data as follows: 6 into I/Y , -1,000,000 into PV (negative because you are investing this
amount), and 70,000 into PMT . Now, press CPT N and you will see that you can make 33.40
withdrawals. Assuming that you can live for about a year on the last withdrawal, then you can afford
to live for about another 34.40 years.
Example 2.4 Solving for the Interest Rate
Solving for I/Y works just like solving for any of the other variables. As has been mentioned
numerous times in this tutorial, be sure to pay attention to the signs of the numbers that you enter
into the TVM keys. Any time you are solving for N, I/Y, or PMT there is the potential for a wrong
answer or error message if you don't get the signs right. Let's look at an example of solving for the
interest rate:
Suppose that you are offered an investment that will cost $925 and will pay you interest of $80 per
year for the next 20 years. Furthermore, at the end of the 20 years, the investment will pay $1,000. If
you purchase this investment, what is your compound average annual rate of return?
Note that in this problem we have a present value ($925), a future value ($1,000), and an annuity
payment ($80 per year). As mentioned above, you need to be especially careful to get the signs
right. In this case, both the annuity payment and the future value will be cash inflows, so they should
be entered as positive numbers. The present value is the cost of the investment, a cash outflow, so it
should be entered as a negative number. If you were to make a mistake and, say, enter the payment
as a negative number, then you will get the wrong answer. On the other hand, if you were to enter all
three with the same sign, then you will get an error message,
Let's enter the numbers: Type 20 into N , -925 into PV , 80 into PMT , and 1000 into FV . Now,
press CPTI/Y and you will find that the investment will return an average of 8.81% per year. This
particular problem is an example of solving for the yield to maturity (YTM) of a bond.
Example 2.5 Annuities Due
In the examples above, we assumed that the first payment would be made at the end of the year,
which is typical. However, what if you plan to make (or receive) the first payment today? This
changes the cash flow from from a regular annuity into an annuity due.
Normally, the calculator is working in End Mode. It assumes that cash flows occur at the end of the
period. In this case, though, the payments occur at the beginning of the period. Therefore, we need
to put the calculator into Begin Mode. To change to Begin Mode, press 2nd PMT . You should see
that it says END on the screen. Now, press 2nd ENTER to change that to BGN and finally
press 2nd CPT to exit from setting the calculation mode. The screen will now show BGN in the
upper-right corner. Note that nothing will change about how you enter the numbers. The calculator
will simply shift the cash flows for you. Obviously, you will get a different answer.
Let's do the college savings problem again, but this time assuming that you start investing
immediately:
Suppose that you are planning to send your daughter to college in 18 years. Furthermore, assume
that you have determined that you will need $100,000 at that time in order to pay for tuition, room
and board, party supplies, etc. If you believe that you can earn an average annual rate of return of
8% per year, how much money would you need to invest at the beginning of each year (starting
today) to achieve your goal?
As before, enter the data: 18 into N , 8 into I/Y , and 100,000 into FV . The only thing that has
changed is that we are now treating this as an annuity due. So, once you have changed to Begin
Mode, just press CPTPMT . You will find that, if you make the first investment today, you only need to
invest $2,472.42. That is about $200 per year less than if you make the first payment a year from
now because of the extra time for your investments to compound.
Be sure to switch back to End Mode after solving the problem. Since you almost always want to be
in End Mode, it is a good idea to get in the habit of switching back. Press 2nd PMT . You should see
that it says BGN on the screen. Now, press 2nd ENTER to change that to END and finally
press 2nd CPT to exit from setting the calculation mode. When in End Mode, the upper-right corner
of the screen will be blank.
Example 2.6 Perpetuities
Occasionally, we have to deal with annuities that pay forever (at least theoretically) instead of for a
finite period of time. This type of cash flow is known as a perpetuity (perpetual annuity, sometimes
called an infinite annuity). The problem is that the BAII Plus Professional has no way to specify an
infinite number of periods using the N key.
Calculating the present value of a perpetuity using a formula is easy enough: Just divide the
payment per period by the interest rate per period. In our example, the payment is $1,000 per year
and the interest rate is 9% annually. Therefore, if that was a perpetuity, the present value would be:
$11,111.11 = 1,000 0.09
If you can't remember that formula, you can "trick" the calculator into getting the correct answer. The
trick involves the fact that the present value of a cash flow far enough into the future (way into the
future) is going to be approximately $0. Therefore, beyond some future point in time the cash flows
no longer add anything to the present value. So, if we specify a suitably large number of payments,
we can get a very close approximation (in the limit it will be exact) to a perpetuity.
Let's try this with our perpetuity. Enter 500 into N (that will always be a large enough number of
periods), 9 into I/Y , and 1000 into PMT . Now press CPT PV and you will get $11,111.11 as your
answer.
Please note that there is no such thing as the future value of a perpetuity because the cash flows
never end (period infinity never arrives).
Please continue on to part III of this tutorial to learn about uneven cash flow streams, net present
value, internal rate of return, and modified internal rate of return.
BAII Plus Professional Tutorial
Part III

In the previous section we looked at the basic time value of money keys and how to use them to
calculate present and future value of annuities. In this section we will take a look at how to use the
BAII Plus Professional to calculate the present and future values of uneven cash flow streams. We
will also see how to calculate net present value (NPV), internal rate of return (IRR), and the modified
internal rate of return (MIRR).
Example 3 Present Value of Uneven Cash
Flows
In addition to the previously mentioned financial keys, the BAII Plus Professional also has
the CF (cash flow) key to handle a series of uneven cash flows. To exit from "cash flow mode" at
any time, simply press 2nd CPT (quit).
Suppose that you are offered an investment which will pay the following cash flows at the end of
each of the next five years:
Period Cash Flow
0 0
1 100
2 200
3 300
4 400
5 500
How much would you be willing to pay for this investment if your required rate of return is 12% per
year?
We could solve this problem by finding the present value of each of these cash flows individually and
then summing the results (the principle of value additivity). However, that is the hard way. Instead,
we'll use the CF key. All we need to do is enter the cash flows exactly as shown in the table. Again,
we must clear the cash flow registers first.In this case we need to press 2nd CE/C (note that
pressing 2nd FV will have no effect on the cash flow registers). The calculator will prompt you to
enter each cash flow and then the frequency with which it occurs. For now, just accept the default
frequency of 1 each time, and make sure that the frequency is always at least 1 for each cash flow.
Now, press CF then 0 Enter down arrow, 100 Enter down arrow (twice), 200 Enter down arrow
(twice), 300 Enter down arrow (twice), 400 Enter down arrow (twice), and finally 500 Enter down
arrow (twice). Now, press the NPV key and enter 12 Enter down arrow when prompted for the
interest rate. To get the present value of the cash flows, press the down arrow key and then CPT .
We find that the present value is $1,000.17922. Note that you can easily change the interest rate by
pressing the up arrow key to get back to that step.
Example 3.1 Future Value of Uneven Cash
Flows
Now suppose that we wanted to find the future value of these cash flows instead of the present
value. Unlike most other financial calculators, the BAII Plus Professional can do this easily. Since we
have already entered the cash flows, just press NPV and enter the interest rate if necessary. Now,
press down arrow twice to get to NFV (Net Future Value). Press CPT and you'll see that the future
value of these cash flows at 12% per year is $1,762.6575. Pretty easy, huh? (Ok, at least its easier
than adding up the future values of each of the individual cash flows.)
Note: At any time, you can return to cash flow mode by pressing CF . This will allow you to scroll
through the cash flows that you entered by using the arrow keys. You can change any of these cash
flows. However, if you are starting a completely new problem you should always
press 2nd CE/C (from within CF mode) to be sure that the cash flows from any previous problem are
cleared. Otherwise, you will very likely get a wrong answer.
Example 4 Net Present Value (NPV)
Calculating the net present value (NPV) and/or internal rate of return (IRR) is virtually identical to
finding the present value of an uneven cash flow stream as we did in Example 3.
Suppose that you were offered the investment in Example 3 at a cost of $800. What is the NPV?
IRR?
To solve this problem we must not only tell the calculator about the annual cash flows, but also the
cost (previously, we set the cost to 0 because we just wanted the present value of the cash flows).
Generally speaking, you'll pay for an investment before you can receive its benefits so the cost
(initial outlay) is said to occur at time period 0 (i.e., today).
Since we have already entered all of the cash flows, we only need to change the initial outlay.
Press CF to get back into cash flow mode, and then input -800 Enter for CF0. Now, press NPV .
Note that we need to supply a discount rate so the calculator will now prompt you for it. Input 12 for I
when prompted, and then Enter down arrow and CPT . You'll find that the NPV is $200.17922.
Example 4.1 Internal Rate of Return
Solving for the IRR is done exactly the same way, except that the discount rate is not necessary.
This time, you'll press IRR and then CPT , and you'll find that the IRR is 19.5382%.
Example 4.2 Modified Internal Rate of Return
The IRR has been a popular metric for evaluating investments for many years primarily due to the
simplicity with which it can be interpreted. However, the IRR suffers from a couple of serious flaws.
The most important flaw is that it implicitly assumes that the cash flows will be reinvested for the life
of the project at a rate that equals the IRR. A good project may have an IRR that is considerably
greater than any reasonable reinvestment assumption. Therefore, the IRR can be misleadingly high
at times. For example, does it really make sense that you would be able to reinvest the cash flows at
a rate of nearly 20% per year as implied by the IRR? Probably not, given that your cost of capital is
10%.
The modified internal rate of return (MIRR) solves this problem by using an explicit reinvestment
rate. The MIRR is the discount rate that equates the initial cost of the investment with the future
value of the cash flows, and it can be interpreted as the compound average annual rate of return that
you will earn on an investment if you reinvest the cash flows at the reinvestment rate. Most financial
calculators don't have an MIRR key like they have an IRR key, but the BAII Plus Professional does.
That means that we can very easily calculate the MIRR.
Suppose that you were offered the investment in Example 3 at a cost of $800. What is the MIRR if
the reinvestment rate is 10% per year?
Begin by making sure that you have entered the cash flows into the CF key, making sure that CF0 is
entered as -800 (the cost of the investment). Now press IRR and then the down arrow to get to the
screen that asks for the RI (reinvestment rate). Type 10 then ENTER . Finally, press the down arrow
key and you will see MOD (for modified IRR) on the screen along with the answer. You will find that
the MIRR is 16.48% per year. In other words, if you reinvest the cash flows at a rate of 10% per year
then your compound average annual rate of return will be 16.48%.
So, we have determined that our project is acceptable at a cost of $800. It has a positive NPV, the
IRR is greater than our 12% required return, and the MIRR is also greater than our 12% required
return.
Please continue on to the next page to learn how to solve problems involving non-annual periods.


Solving Problems with Non-Annual Periods on the
TI BAII Plus Professional

Many, perhaps most, time value of money problems in the real world involve other than annual time
periods. For example, most consumer loans (e.g., mortgages, car loans, credit cards, etc) require
monthly payments. All of the examples in the previous pages have used annual time periods for
simplicity. On this page, I'll show you how easy it is to deal with non-annual problems.
General Considerations
The first thing to understand is that all of the principles that you have learned to apply for annual
problems still apply for non-annual problems. In truth, nothing has changed at all. If you try to think in
terms of "periods" rather than years, you will be ahead of the game. A period can be any amount of
time. Most common would be daily, monthly, quarterly, semiannually, or annually. However, a time
period could be any imaginable amount of time (e.g., seven weeks, hourly, three days).
The first, and most important, thing to think about when dealing with non-annual periods is the
number of periods in a year. The reason that this is so important is because you must be consistent
when entering data into the BAII Plus Professional. The numbers entered into
the N , I/Y and PMT keys must agree as to the length of the time periods being used. So, if you are
working on a monthly problem, then N should be the total number of months, I/Y should be the
monthly interest rate, and PMT should be the monthly annuity payment.
An Example
Very often in a problem, you are given annual numbers but then told that "payments are made on a
monthly basis," or that "interest is compounded daily." In these cases, you must adjust the numbers
given in the problem. Let's look at an example:
You are considering the purchase of a new home for $250,000. Your banker has informed you that
they are willing to offer you a 30-year, fixed rate loan at 7% with monthly payments. If you borrow the
entire $250,000, what is the required monthly payment?
Notice that we are told that the loan term is 30 years and the interest rate is 7% per year (that is
implied, not explicitly stated). So, you might be forgiven for expecting that a period is one year.
However, on further reading you see that the payments must be made every month. Therefore, the
length of a period is one month, and you must convert the variables to a monthly basis in order to
get the correct answer.
Since there are 12 months in a year, we calculate the total number of periods by multiplying 30 years
by 12 months per year. So, N is 360 months, not 30 years. Similarly, the interest rate is found by
dividing the 7% annual rate by 12 to get 0.5833% per month. Note that we do not make any
adjustments to the PV ($250,000) because it occurs at a single point in time, not repeatedly. The
same logic would apply if there was an FV in this problem. When you solve for the payment, the
calculator will automatically give you the monthly (per period to be exact) payment amount.
In this problem, then, we would solve for the payment amount by entering 360 in N , 0.5833 into I/Y ,
and 250,000 into PV . When you press CPT PMT you will find that the monthly payment is
$1,663.26.
One thing to be careful about is rounding. For example, when calculating the monthly interest rate,
you should do the calculation in the calculator and then immediately press the I/Y key. Do not do the
calculation and then write down the answer for later entry. If you do, you will be truncating the
interest rate to the number of decimal places that are shown on the screen, and your answer will
suffer from the rounding. The difference may not be more than a few pennies, but every penny
matters. Try sending your lender a payment that is consistently three cents less than required and
see what happens. It probably won't be long before you get a nasty letter.
Adjust First, Not After, Solving the Problem
You might be tempted to think that you could treat the problem as an annual one, and then adjust
your answer to be monthly. Don't do that! The math simply doesn't work that way. To prove it, let's
input annual numbers, and then convert the annual payment to monthly by dividing by 12. Enter 30
into N , 7 into I/Y , and 250,000 into PV . When you press CPT PMT , you will find that the annual
payment would be $20,146.60. However, you have to make monthly payments so if we divide that
by 12 we get a monthly payment of $1,678.88.
Do you see the problem? If you do the problem this way, you get an answer that is $15.63 too high
every month. So, when you make the adjustments matters. Always adjust your variables before
solving the problem. The reason for the difference is the compounding of interest. If you have read
through my tutorial on the Mathematics of Time Value of Money, then you know that the more
frequently interest is compounded, the smaller the payment has to be in order to grow to a particular
future value.
Using the BAII Plus Professional Payments per
Year Setting
You may have noticed that the BAII Plus Professional can semi-automatically adjust for payment
frequency for you by using the P/Y setting. I strongly recommend that you avoid this feature because
I think it causes more problems than it solves. The reason is that this setting is hidden away, and if
you forget to change it you will probably get a wrong answer. It can be difficult to spot problems
caused by this setting.
Regardless of my feelings about this setting, I'm going to tell you how to use it. If you look at
the I/Y key you will notice that the second function of this key is P/Y, which means "payments per
year." If you set this value to, say, 12 then the calculator will assume monthly compounding and
adjust the interest rate appropriately. However, and this is very important, it will not adjust the
number of periods or the payment amount! That makes this feature virtually worthless.
Let's do the problem again, but using this "feature." First, set the payments per year to 12 (monthly)
by pressing 2nd I/Y . Type 12 at the prompt, press ENTER and then press 2nd CPT to exit. Now, we
can enter the data. 360 into N (again, you still have to enter the total number of periods), 7 into I/Y ,
and 250,000 into PV . Now, solve for the payment by pressing CPT PMT and you will find that the
monthly payment is $1,663.26.
The answer is correct, but what did you save by using that "shortcut?" Nothing at all. In fact, it takes
an extra keystroke or two to use this feature. Furthermore, if you forget to change the setting when
you do the next problem, you will get the wrong answer unless that problem also happens to use
monthly compounding.
My recommendation is to follow the simple steps that I outlined above: Set P/Y to 1 and then forget
about it forever. Always make N the total number of periods, I/Y the interest rate per period,
and PMT the payment per period.
I hope that you have found this tutorial to be helpful. If this tutorial is not enough, TI offers a free
"Guidebook."


Bond Valuation on the BAII Plus Professional
Calculator
A bond is a debt instrument, usually tradeable, that represents a debt owed by the issuer to the
owner of the bond. Most commonly, bonds are promises to pay a fixed rate of interest for a number
of years, and then to repay the principal on the maturity date. In the U.S. bonds typically pay interest
every six months (semi-annually), though other payment frequencies are possible.
The purpose of this section is to show how to calculate the value of a bond, both on a coupon
payment date and between payment dates. If you aren't familiar with the terminology of bonds,
please check theBond Terminology page. If you aren't comfortable doing time value of money
problems on the TI BAII Plus Professional, you should work through that tutorial first.
You may also be interested in my tutorial on calculating bond yieldsusing the TI BAII Plus
Professional.
Bond Cash Flows
As noted above, a bond typically makes a series of semiannual interest payments and then, at
maturity, pays back the face value. Let's look at an example:
Draw a time line for a 3-year bond with a coupon rate of 8% per year paid semiannually. The bond
has a face value of $1,000.
The bond has three years until maturity and it pays interest semiannually, so the time line needs to
show six periods. The bond will pay 8% of the $1,000 face value in interest every year. However, the
annual interest is paid in two equal payments each year, so there will be six coupon payments of
$40 each. Finally, the $1,000 will be returned at maturity (i.e., the end of period 6). Therefore, the
time line looks like the one below:

We will use this bond throughout the tutorial.
Bond Valuation on a Coupon Date
We will begin our example by assuming that today is either the issue date or a coupon payment
date. In either case, the next payment will occur in exactly six months. This will be important
because we are going to use the time value of money keys to find the present value of the cash
flows.
The value of any asset is the present value of its cash flows. Therefore, we need to know two things:
1. The size and timing of the cash flows.
2. The required rate of return (discount rate) that is appropriate given the riskiness of the cash
flows.
We have already identified the cash flows above. Take a look at the time line and see if you can
identify the two types of cash flows. Notice that the interest payments are a $40, six-period regular
annuity. The face value is a $1,000 lump sum cash flow. Using the principle of value additivity, we
know that we can find the total present value by first calculating the present value of the interest
payments and then the present value of the face value. Adding those together gives us the total
present value of the bond.
We don't have to value the bond in two steps, however. The TVM keys on the BAII Plus Professional
can handle this calculation as we will see in the next example:
Assuming that your required return for the bond is 9.5% per year, what is the most that you would be
willing to pay for this bond?
We can calculate the present value of the cash flows using the TVM keys. Enter the data: 6 into N ,
4.75 into I/Y (9.5/2 = 4.75), 40 into PMT , and 1,000 into FV . Now, press CPT PV and you will find
that the value of the bond is $961.63. (If you get $1,213.29 instead, then you have the calculator set
to assume monthly compounding. Please see the Initial Setup section of the BAII Plus Professional
tutorial for how to correct this problem.)
Notice that the bond is currently selling at a discount (i.e., less than its face value). This discount
must eventually disappear as the bond approaches its maturity date. A bond selling at a premium to
its face value will slowly decline as maturity approaches. In the chart below, the blue line shows the
price of our example bond as time passes.

The red line shows how a bond that is trading at a premium will change in price over time. Both lines
assume that market interest rates stay constant. In either case, at maturity a bond will be worth
exactly its face value. Keep this in mind as it will be a key fact in the next section.
Bond Valuation In-between Coupon Dates, Part 1
In the previous section we saw that it is very easy to find the value of a bond on a coupon payment
date. However, calculating the value of a bond in-between coupon payment dates is more complex.
As we'll see, the reason is that interest does not compound between payment dates. That means
that you cannot get the correct answer by entering fractional periods (e.g., 5.5) into N .
Note that in this section we will deal with the generic idea of periods, and use the TVM keys. This
section is important so that you understand the process of valuing bonds between coupon payment
dates. In the next section, we will use the BOND key and deal with exact dates.
Let's start by using the same bond, but we will now assume that 6 months have passed. That is,
today is now the end of period 1. What is the value of the bond at this point?
To figure this out, note that there are now 5 periods remaining until maturity, but nothing else has
changed. Therefore, simply change the value in N to 5. Now calculate the PV, and you will find that
the value of the bond at the end of period 1 will be $967.30. Notice that the value of the bond has
increased a little bit since period 0. As noted previously, this is because the discount must eventually
vanish as the maturity date approaches. The bond must be worth exactly $1,000 at maturity because
that is how much it will pay at that time.
Now, is there another way that we might arrive at that period 1 value? Of course. Remember that
your required return is 4.75% per period. Therefore, the value of the bond must increase by that
amount each period. If we calculate the future value of $961.63 (the value at period 0) for 1 period at
4.75% we should get the same answer:
961.63(1.0475) = 1,007.30
Wait a minute! That's not the same answer. However, remember that this is the total value of your
holdings at the end of period 1. The value that we calculated previously ($967.30) did not include the
$40 coupon payment that you received. If we subtract that, you can see that we do get the same
result:
1,007.30 - 40 = 967.30
This is one of the key points that you must understand to value a bond between coupon payment
dates.
Let me recap what we just did: We wanted to know the value of the bond at the end of period 1. So,
we calculated the value as of the previous coupon payment date, and then calculated the future
value of that price. Then, we subtracted the amount of accrued interest to get to the quoted price of
the bond.
We can use exactly this same procedure to find the value of the bond in-between payment dates.
Using the same bond as above, what will the value be after 3 months have passed in the current
period?Assume that interest rates have not changed.
So, we are now looking for the value of the bond as of period 0.5 (i.e., exactly halfway through the
first payment period). Unfortunately, the TVM keys can only help us with this for the first step. Recall
that we first need to calculate the PV of the cash flows as of the previous payment date (period 0).
Re-enter the data: 6 into N , 4.75 into I/Y , 40 into PMT , and 1,000 into FV . Now, press CPT PV . As
before, we find that the value of the bond at time period 0 was $961.63.
Now we need to find the future value of $961.63 one-half of a period in the future:
961.63(1.0475)
0.5
= 984.20
Remember that this gives us the "dirty" price of the bond (it includes the accrued interest).
To do the above calculation in the calculator, we are going to grab the PV that we calculated (the
961.63) by pressing RCL PV . Now, you will need to change the sign of the PV, so press +/- . Now,
multiply that by 1.0475^0.5. You will find that this answer is $984.20 as we found above.
The process so far is shown in the graphic below:

Now, to get the clean price (doesn't include accrued interest, this is the price that would be quoted
by a dealer) at period 0.5 we need to subtract the accrued interest.
Because interest accrues equally on each day of the payment period, we can calculate the accrued
interest by multiplying the total interest for the period by the fraction of the period that has elapsed:
Accrued Interest = Total Interest x Fraction of Period Elapsed
In this example, that works out to $20:
Accrued Interest = 40 x 0.5 = 20
Finally, to find the clean (quoted) price, we subtract the accrued interest from the dirty price:
Clean Price = Dirty Price - Accrued Interest
In this example, we get $964.20:
Clean Price = 984.20 - 20 = 964.20
The same procedure could be done for any fractional period. For example, if 2 months (out of 6)
have elapsed, then the fraction is 1/3. So, the clean price of the bond would be $963.28. Prove that
for yourself to make sure that you understand the process.
Please note that you cannot get the correct answer by entering a fractional number into N . In this
case, if you simply entered 5.5 into N (because there are 5.5 periods remaining until maturity) you
would get an answer of $964.43. That is close, but it is not correct and it is not "close enough." The
reason that it won't work is because the formula used by the calculator assumes that the interest
payments are an annuity. That is, the time between the cash flows must be exactly the same in
every case. Clearly, that isn't true when valuing a bond between coupon payment dates.
Bond Valuation In-between Coupon Dates, Part 2
Unlike most financial calculators, the BAII Plus Professional can truly handle real world bond
valuation problems. That is because it has the BOND key, which allows you to enter exact dates and
to use the correct day-count basis (but only actual/actual or 30/360).
Let me recast our bond valuation problem slightly, so that it includes exact dates and other
information that we will need:
What is the value of a bond with an 8% coupon rate that last paid interest on 6/15/2007? Assume
that the settlement date for a trade made today is 9/15/2007, and that the bond will mature on
6/15/2010. The bond pays interest semiannually, and your required return is 9.5% per year. The
day-count basis is 30/360.
To get into the bond worksheet, press 2nd BOND (the 9 key). The first thing you are asked for is
thesettlement date (SDT). In the BAII Plus Professional, we can enter dates in either the mm.ddyy or
dd.mmyy formats. In this case, type 09.1507 ENTER . You should see the date change to 9-15-2007.
Press the down arrow button and type 8 ENTER for the coupon rate (CPN). Note that we entered the
annual coupon rate because the calculator will automatically adjust for the payment frequency.
Press the down arrow key again, and type 06.1510 ENTER for the redemption date (RDT).
Next, you will be asked for the redemption value (RV), which is the amount that you will receive at
maturity (or call date). This number must be entered as a percentage of the face value, so you will
type 100 ENTER . This indicates that you will be receiving 100% of the face value at maturity.
After pressing the down arrow key again, you will be prompted for the day-count basis. You can
choose either actual/actual (ACT) or 30/360 (360). If necessary, press 2nd ENTER to change the
day-count basis so that the screen shows 360.
Press the down arrow key again and you will be asked for the number of coupon payments per year.
You can choose either 1 per year (1/Y) or 2 per year (2/Y). This bond, as do most in the US, pays
interest semiannually so you should choose 2/Y. If necessary, you can change this setting by
pressing 2nd ENTER .
Next, we need to enter the required return (YLD). Type 9.5 and then press ENTER . Finally, to
calculate the value of the bond, press the down arrow button to get to PRI (price). Press CPT and
you will see that the price is 96.42.
Note that, as is the convention in the bond market, the price is given as a percentage of the face
value. In this case, the price is 96.42% of the $1,000 face value, or $964.20. This is the same price
that we found in the previous section.
One more thing: You can calculate the accrued interest using the BAII Plus Professional. After
calculating the price, press the down arrow key and you will see AI. It will show that the accrued
interest is 2.00% of the face value, or $20.00. Again, this is the same amount that we found in Part
1.
Bond Price Quotes and Accrued Interest
It is important to understand that bond prices are quoted by dealers without the accrued interest. So,
if you get a quote of $950 to purchase a bond, then you will pay $950 plus however much interest
has accrued to the seller of the bond since the last coupon payment. That is, the invoiced price is the
quoted price plus accrued interest. There are three terms that you should understand:
Accrued Interest
Accrued interest is the interest that has been earned, but not yet been paid by the bond
issuer, since the last coupon payment. Note that interest accrues equally on every day
during the period. That is, it does not compound. So, halfway through the period, you will
have accrued exactly one-half of the period's interest payment. It works the same way for
any other fraction of a payment period.
Clean Price
The "clean price" is the price of the bond excluding the accrued interest. This is also known
as the quoted price.
Dirty Price
The "dirty price" is the total price of the bond, including accrued interest. This is the amount
that you would actually pay (or receive) if you purchase (or sell) the bond.
The dirty price is simply the clean price plus the accrued interest.
One final point: In the "real world" bond prices are quoted as a percentage of their face value, not in
dollars. So, if a bond dealer quoted the price of our example bond, they would say 96.443, not
964.43. This practice allows a bond price to be quoted without also having to state its face value,
and it makes price quotes comparable across different bonds regardless of their face value.
I hope that you have found this tutorial to be useful. Please continue on to the next page to learn
about calculating the various bond return measures (current yield, yield to maturity, and yield to call).


Bond Yield Calculation on the BAII Plus
Professional Calculator
One of the key variables in choosing any investment is the expected rate of return. We try to find
assets that have the best combination of risk and return. In this section we will see how to calculate
the rate of return on a bond investment. If you are comfortable using the TVM keys, then this will be
a simple task. If not, then you should first work through my TI BAII Plus Professional tutorial.
The expected rate of return on a bond can be described using any (or all) of three measures:
Current Yield
Yield to Maturity
Yield to Call
We will discuss each of these in turn below. In the bond valuationtutorial, we used an example bond
that we will use again here. The bond has a face value of $1,000, a coupon rate of 8% per year paid
semiannually, and three years to maturity. We found that the current value of the bond is $961.63.
For the sake of simplicity, we will assume that the current market price of the bond is the same as
the value. (You should be aware that intrinsic value and market price are two different, though
related, concepts.)
The Current Yield
The current yield is a measure of the income provided by the bond as a percentage of the current
price:

There is no built-in function to calculate the current yield, so you must use this formula. For the
example bond, the current yield is 8.32%:

Note that the current yield only takes into account the expected interest payments. It completely
ignores expected price changes (capital gains or losses). Therefore, it is a useful return measure
primarily for those who are most concerned with earning income from their portfolio. It is not a good
measure of return for those looking for capital gains. Furthermore, the current yield is a useless
statistic for zero-coupon bonds.
The Yield to Maturity, Part 1
Unlike the current yield, the yield to maturity (YTM) measures both current income and expected
capital gains or losses. The YTM is the internal rate of return of the bond, so it measures the
expected compound average annual rate of return if the bond is purchased at the current market
price and is held to maturity.
In the case of our example bond, the current yield understates the total expected return for the bond.
As we saw in the bond valuation tutorial, bonds selling at a discount to their face value must
increase in price as the maturity date approaches. The YTM takes into account both the interest
income and this capital gain over the life of the bond.
There is no formula that can be used to calculate the exact yield to maturity for a bond (except for
trivial cases). Instead, the calculation must be done on a trial-and-error basis. This can be tedious to
do by hand. Fortunately, the BAII Plus Professional has the time value of money keys, which can do
the calculation quite easily. Technically, you could also use the IRR function, but there is no need to
do that when the TVM keys are easier and will give the same answer.
To calculate the YTM, just enter the bond data into the TVM keys. We can find the YTM by solving
for I/Y . Enter 6 into N , -961.63 into PV , 40 into PMT , and 1,000 into FV . Now, press CPT I/Y and
you should find that the YTM is 4.75%.
But wait a minute! That just doesn't make any sense. We know that the bond carries a coupon rate
of 8% per year, and the bond is selling for less than its face value. Therefore, we know that the
YTM must be greater than 8% per year. You need to remember that the bond pays interest
semiannually, and we entered N as the number of semiannual periods (6) and PMT as the
semiannual payment amount (40). So, when you solve for I/Y the answer is a semiannual yield.
Since the YTM is always stated as an annual rate, we need to double this answer. In this case, then,
the YTM is 9.50% per year.
So, always remember to adjust the answer you get for I/Y back to an annual YTM by multiplying by
the number of payment periods per year.
The Yield to Maturity, Part 2
If you worked through the bond valuation tutorial, then you have already seen how we can use the
bond worksheet (BOND) to calculate the value of a bond between coupon payment dates. Rather
than present essentially the same material again, I'll just point you to Bond Valuation In-between
Coupon Dates, Part 2.
The procedure for finding the yield to maturity in-between coupon payment dates is identical, except
that you need to enter the current market price of the bond for PRI and then solve for the yield
(YLD).
The Yield to Call
Many bonds (but certainly not all), whether Treasury bonds, corporate bonds, or municipal bonds are
callable. That is, the issuer has the right to force the redemption of the bonds before they mature.
This is similar to the way that a homeowner might choose to refinance (call) a mortgage when
interest rates decline.
Given a choice of callable or otherwise equivalent non-callable bonds, investors would choose the
non-callable bonds because they offer more certainty and potentially higher returns if interest rates
decline. Therefore, bond issuers usually offer a sweetener, in the form of a call premium, to make
callable bonds more attractive to investors. A call premium is an extra amount in excess of the face
value that must be paid in the event that the bond is called.
The picture below is a screen shot (from the FINRA TRACE Web site on 8/17/2007) of the detailed
information on a bond issued by Union Electric Company. Notice that the call schedule shows that
the bond is callable once per year, and that the call premium declines as each call date passes
without a call. If the bond is called after 12/15/2015 then it will be called at its face value (no call
premium).

It should be obvious that if the bond is called then the investor's rate of return will be different than
the promised YTM. That is why we calculate the yield to call (YTC) for callable bonds.
The yield to call is identical, in concept, to the yield to maturity, except that we assume that the bond
will be called at the next call date, and we add the call premium to the face value. Let's return to our
example:
Assume that the bond may be called in one year with a call premium of 3% of the face value. What
is the YTC for the bond?
In this case, the bond has 2 periods before the next call date, so enter 2 into N . The current price is
the same as before, so enter -961.63 into PV . The payment hasn't changed, so enter 40 into PMT .
We need to add the call premium to the face value, so enter 1,030 into FV . Solve for I/Y and you
will find that the YTC is 7.58% per semiannual period. Remember that we must double this result, so
the yield to call on this bond is 15.17% per year.
Now, ask yourself which is more advantageous to the issuer: 1) Continuing to pay interest at a yield
of 9.50% per year; or 2) Call the bond and pay an annual rate of 15.17%. Obviously, it doesn't make
sense to expect that the bond will be called as of now since it is cheaper for the company to pay the
current interest rate.
I hope that you have found this tutorial to be helpful.