Compound Interest Calculations, 2011-12.pptVIP

Solution (contd) Discounting factor 5 - 0 = e = e -0.5 = 0.606531 PV = 2000 x 0.416862 x 0.606531 = 505.68 GEOMETRIC SERIES a + aR + aR2 + aR3 + . . . + aRn-1 Examples (i) 2 + 10 + 50 + 250 (ii) 1 + 1/2 + 1/4 + 1/8+ 1/16 Sn = where Sn = sum of the series a = first term of the series R = the common ratio n = the number of terms. PROOF Sn = a + aR + aR2 + . . . aRn-1 (1) Multiply (1) by R RSn = aR + aR2 + aR3 + . . . aRn (2) (1) - (2) ? Sn - RSn = a - aRn Sn (1 - R) = a(1 - Rn) (i) a = 2, R = 5, n = 4 ? S4 = 312 (ii) a = 1, R = 1/2, n = 5 ? S5 = 115/16 PRESENT VALUE OF AN ANNUITY-CERTAIN (1) Time An annuity-certain is a series of payments at fixed intervals of time for a fixed period of time. Annuities paid annually in arrears Present value of this annuity is: PRESENT VALUE OF AN ANNUITY-CERTAIN (2) Example 13 What is the present value of ￡200 received at the end of each of the next 10 years if the rate of interest (or “discount rate”) is 7% per annum? Solution ￡200 @ 7% = ￡200 × 7.0236 = ￡1404.72 PRESENT VALUE OF AN ANNUITY-CERTAIN (3) Annuities paid annually in advance We are valuing the same series of payments as before but discounting them all for one period fewer. Present value of this annuity is: Hence PRESENT VALUE OF AN ANNUITY-CERTAIN (4) Example 14 What is the present value of payments of ￡1,000 received at the beginning of each of the next 15 years if the rate of interest is 12% per annum? (Can use compound interest tables at the end of the book Investment Mathematics, p407) Solution We know that So present value = 1000(1.12) @12% = 1000(1.12)(6.8109) = ￡7628.2 Exa