Documente Academic
Documente Profesional
Documente Cultură
Financial Mathematics
Jonathan Ziveyi1
1 University of New South Wales
Risk and Actuarial Studies, Australian School of Business
j.ziveyi@unsw.edu.au
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Financial Mathematics
Plan
Module 3: Loan Valuation and Project Appraisal Techniques
Introduction
Allowing for Tax
Analysis of Loan Schedules and Repayments
Sinking Funds
Loans at a Flat Rate of Interest
Loan Valuation Example
Fixed Income Securities and Bonds
Pricing Bonds
Bond Valuation Example
Definitions of Yield, IRR and MIRR Rates
Investment Decision Criteria
Sensitivity of Results and Duty of Disclosure
Project Appraisal Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Introduction
minus costs:
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sales
salvage value of assets
expenses
transaction costs
taxes
depreciation of assets
cost of debt
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Introduction
for a company
personal wealth
personal loan
equity (shares)
debt (loans, bonds)
for a government
taxes
debt (treasury bonds)
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Introduction
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Allowing for Tax
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Allowing for Tax
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in many cases price and yield calculations allowing for tax can
be done analytically (using financial mathematics formulae),
"by hand" and using a calculator
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Allowing for Tax
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
Loans Definitions:
Equation of value
L = K1 v + K2 v 2 + . . . + Kn v n
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at effective rate i.
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
Denote:
It
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
at time 0
OB0 = L
at time 1
I1 = iOB0 = iL
PR1 = K1 I1 = K1 iOB0
OB1 = OB0 (1 + i) K1 = OB0 (K1 iOB0 )
= OB0 (K1 I1 ) = OB0 PR1
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
In general we have
It+1 = iOBt
PRt+1 = Kt+1 It+1
OBt+1 = OBt (1 + i) Kt+1 = OBt (Kt+1 It+1 )
= OBt PRt+1
Total repayments
KT =
Xn
Kt
IT =
Xn
It
total interest
and
L = KT IT =
n
X
t=1
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PRt
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
Loan Schedule In practice it is often much easier to set out all the
information in a "loan schedule" providing information (for each
period) on:
Payments
Interest Due
Principal Repayments
Principal Outstanding
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
Example For the $1000 5 year loan with level repayments, what are
the interest and principal components in each year? Give a
repayment schedule.
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
n
X
s=t+1
OBt = L (1 + i)
t
X
s=0
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Analysis of Loan Schedules and Repayments
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sinking Funds
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sinking Funds
L
.
sn j
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sinking Funds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sinking Funds
Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loans at a Flat Rate of Interest
L+I
n
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loans at a Flat Rate of Interest
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loans at a Flat Rate of Interest
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loan Valuation Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loan Valuation Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Loan Valuation Example
You may need to constraint the interest rate and the price to
be positive.
Note:
(x y )+ = max(x y , 0).
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Fixed Income Securities and Bonds
types of bonds
but also
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the government
private companies
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Fixed Income Securities and Bonds
Government Bonds
Government Bonds:
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Fixed Income Securities and Bonds
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Fixed Income Securities and Bonds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Fixed Income Securities and Bonds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
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the seller will require the interest accumulated since the last
coupon date to be paid by the buyer
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
P = vi d [C + Gan i + 100v n ]
where:
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
Market price Two bonds with the same cash flows and the same
yield will have a different purchase price if coupons payment dates
are different, which may be confusing. Hence, bonds are usually
quoted at a market price. We distinguish:
Price-plus-accrued:
Market price
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Pricing Bonds
at lenders option
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
Price =
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
Price = (1 0.3)
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
0.06
(40,000) a10
2
+40,000 (1.05) v
+ (1 0.3)
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40000
0.15 40,000 (1.05)
P v 10
100000
0.06
(60,000) a20
2
+60,000 (1.05) v
at
10
20
60000
0.15 60,000 (1.05)
P v 20
100000
4.0
%
2
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Bond Valuation Example
We have
P = 840 8.982585 + [42,000 0.15 (42,000 0.4P)] 0.820348
+1260 16.351433 + [63,000 0.15 (63,000 0.6P)] 0.672971
and thus
(1 0.049221 0.060567) P = 7,545.371 + 29,286.4236
+20,602.8056 + 36,037.597
93,472.197
= 105,000.
P =
0.890212
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
accumulated value
investment cost
1/length of investment
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
0
1
2
3
4
5
Option 1
-1000.00
100.00
200.00
300.00
400.00
500.00
Option 2
-1000.00
533.20
350.00
250.00
150.00
50.00
Yield = IRR!
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1/5
1 =
1762.90
1000
1/5
1 = 12.01%
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
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Inflows accumulated @ 3%
1000
1/5
1 =
1561.37
1000
1/5
1 = 9.32%
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
Numerical example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
Solution
MIRR:
(Accum. value @ reinv. rate) = (Invmt cost)(1+MIRR)length of invmt
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Definitions of Yield, IRR and MIRR Rates
Multiple IRR If cash flows are non conventional (change sign more
than once), there may be several IRR...
Example:
t
0
1
2
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CFt
-59
= NPV(i):
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Investment Decision Criteria
Decision criteria
1. Payback period
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Investment Decision Criteria
5. MIRR
6. Profitability index
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the ratio
(PV of repayments) / (initial investment)
remember the NPV is the difference:
(PV of repayments) - (initial investment)
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Investment Decision Criteria
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Investment Decision Criteria
Numerical example
In this example, what is the decision that the various decision
criteria that were introduced would yield?
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sensitivity of Results and Duty of Disclosure
Assume that these are all incurred at the middle of the year on
average.
At the end of the 5th year the business will be sold for a total
of 10m.
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sensitivity of Results and Duty of Disclosure
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sensitivity of Results and Duty of Disclosure
7. Reporting
A Member must ensure that his or her reporting (whether oral or
written) in respect of Professional Services provided:
(a) is appropriate, having regard to:
1. the intended audience;
2. its fitness for the purposes for which such
reporting may be required or relevant;
3. the likely significance of the reporting to its
intended audience;
4. the capacity in which the Member is acting; and
5. any inherent uncertainty and risks in relation to
the subject of the report;
(b) complies with any relevant Professional Standards.
Institute of Actuaries of Australia Code of Professional Conduct
(November 2009, Section 7)
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sensitivity of Results and Duty of Disclosure
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Sensitivity of Results and Duty of Disclosure
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Project Appraisal Example
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Project Appraisal Example
Loan schedule
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Project Appraisal Example
Taxable income
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Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Project Appraisal Example
Financial Mathematics
Module 3: Loan Valuation and Project Appraisal Techniques
Project Appraisal Example
NPV check
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