Discouting Cash Flows Lesson 1 PDF
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This lesson explains discounting cash flows, particularly focusing on present value calculations for goal-based investing and pure discount bonds. It covers various compounding methods and the impact of maturity and discount rates on present value. The document also includes exercises and examples. It is suitable for undergraduate-level finance courses.
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**Discouting Cash Flows** Objectives: - Calculate the present value of a cash flow: - With math formulas; - With Excel formulas. - Use present values to calculate affordability thresholds in **goal-based investing**. - Price **pure discount bonds** with a zero-coupon yield curve....
**Discouting Cash Flows** Objectives: - Calculate the present value of a cash flow: - With math formulas; - With Excel formulas. - Use present values to calculate affordability thresholds in **goal-based investing**. - Price **pure discount bonds** with a zero-coupon yield curve. 1. **Calculating Present Values** A white background with black text and colorful letters Description automatically generated common compounding conventions for discount rate: - Annual - Semiannual - Quarterly - Monthly (r : we assume the rate is annual, so to make it semiannual, we divide the rate by 2) To interpret the present value:  CHECK FORMULAS : A screenshot of a math problem Description automatically generated Goal-based investing : Goal-based investing means investing to reach one or more goal(s). - ▶ A target amount of wealth 𝐺 in 𝑛 periods is an affordable goal if its present value is less than or equal to current wealth: - ▶ "Affordable" means that there exists at least one investment strategy that secures the goal: - E.g., purchase a pure discount bond that pays off 𝐺 in 𝑛 periods. - If we have less than the present value, we are not affordable. Checking Goal Affordability (Exercise) : A close-up of a text Description automatically generated 2. **Impact of Maturity, Discount Rate and Compounding Frequency**  Negative relationship between the PV and the rate. And The more the maturity the less the present value. A screenshot of a spreadsheet Description automatically generated  3. **Pure discount bonds**  The more you invest in a bond, the more you have safety. 4. **Pure discount bond princing with the zero-coupon yield curve** A white paper with blue text and numbers Description automatically generated **They must trade at the same price : absence of arbitrage securities / opportunity / princing ?** **When there is inflation, federal reserve increases interest rates.** A screenshot of a math problem Description automatically generated **We need to calculate the bond maturity in years.**
