Escolar Documentos
Profissional Documentos
Cultura Documentos
Financial Mathematics
Jonathan Ziveyi1
1 University of New South Wales
Risk and Actuarial Studies, Australian School of Business
j.ziveyi@unsw.edu.au
1/90
Financial Mathematics
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
2/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
3/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
3/90
amount
timing
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
4/90
how?
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
5/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
Procedure:
6/90
"bring back or forth" all cash flows to the point of time you
have chosen
add them up
compare!
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
7/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
8/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
Time value of money How much would you pay to buy a security
that is guaranteed to give you $100 in 1 years time?
8/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
Time is money!
Interest is a mathematical tool to embody
9/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
Mathematical model
Consider an amount of money invested for a period of time.
t: the length of time for which the amount has been invested
A(t): amount function or accumulated amount function
Assuming these are two equivalent cash flows at two different point
in time, how can we link them using interest?
10/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
We have
A(t + k)
a(t + k)
=
,
A(t)
a(t)
which means
A(t + k) = A(t)
11/90
a(t + k)
.
a(t)
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
12/90
A(t + k) A(t)
a(t + k) a(t)
=
.
A(t)
a(t)
(1.1)
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
it,k
=
=
13/90
A(t + k)
A(t + k) A(t)
=
1
A(t)
A(t)
a(t + k) a(t)
= a(k) 1.
a(t)
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
Forms of interest
14/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
A Mathematical Model of Interest
15/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
16/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
16/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
17/90
30/06/2010
01/01/2011
30/06/2011
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
18/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
19/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
20/90
6=
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
21/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
or alternatively
a(t + k)
= (1 + i)k = a(k),
a(t)
22/90
t, k 0.
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
Numerical Example
A Bank accepts deposits for terms up to 3 years and pays interest
on maturity. How much interest would it pay on a deposit of
$20,000 for a term of 1 year and 33 days if the interest rate is 5%
p.a. effective?
23/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Simple and Compound Interest
General questions
1. What happens to the accumulation if i ?
i ?
24/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
25/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
25/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
and for d :
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
Remember: i
=
=
Now:
=
=
a(1) a(0)
a(0)
A(1) A(0)
= a(1) = (1 + i)
A(0)
a(1) a(0)
a(1)
A(1) A(0)
1
= a(1) =
A(1)
1d
Financial reasoning:
27/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
1
.
1d
1
1 dt
28/90
1
1d
t
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
Numerical Example
In the US Treasury Bills are quoted using simple discount on the
basis of a 360 day year.
Consider a US T-Bill with a face value of 500,000 and maturity in
180 days time. Suppose that this is sold to yield 6%p.a (simple
discount). What are the proceeds of the sale?
29/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
d
1d
i
=
1+i
= iv
= 1v
i
d
i d
30/90
= id
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
Intuition behind d = 1 v ?
31/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Discount Interest
Intuition behind i d = id ?
32/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
33/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
33/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
34/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
35/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
i (m) >i
??
36/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
37/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
38/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
1
39/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Nominal Interest
40/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
41/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
41/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
i (m) m (m 1)
= lim 1 + m
+
m
m
2!
i ()
= 1+i
+
2!
i ()
= e
or e ,
()
2
i ()
+
3!
3
i (m)
m
!2
+ ...
+ ...
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
d (m) m (m 1)
= lim 1 m
+
m
m
2!
= 1d
= e d
()
()
d ()
+
2!
2
d ()
3!
3
d (m)
+ ...
!2
...
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
We have
1 d = e d
()
and 1 + i = e i
Now
1d =v =
()
1
.
1+i
Thus,
i () = d ()
and, in general,
d < . . . < d (m) < . . . < d () = = i () < . . . < i (m) < . . . < i.
44/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
45/90
A(t + t) A(t)
.
A(t)t
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
(t) =
46/90
lim
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
(s)ds
ln A(s)|t0
s=0
= ln A(t) ln A(0)
A(t)
= ln
.
A(0)
Thus we have
A(t) = A(0) exp
Z
(s)ds
and
a(t) = exp
Z
(s)ds .
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Force of Interest
48/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
49/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
49/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
Notation Let
50/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
1+i
i
r =
.
1+
1+
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
(1 + )t
Both methods are equivalent.
52/90
1
1+r
t
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
53/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
Method 2: the real value, and discount with the real interest
rate.
54/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
Asset 1 Method 1:
PV
100, 000
40
1 + .09
4
= 41, 064.58
=
Method 2:
Real value =
PV =
55/90
100, 000
40 = 60, 841.33
1 + .05
4
60, 841.33
(1.00987654)40
= 41, 064.57
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Real and Money Interest
Asset 2 Method 1:
PV
40
Method 2:
PV
56/90
100, 000
(1.00987654)40
= 67, 494.54
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
57/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
57/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
Practical examples
...
Note
58/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
See Broverman and Sherris for the main definitions and examples.
59/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
A(t)
.
a(t)
1
a(1)
1
1+i
= 1d
=
= d /i
Powers of the discount factor can be used to discount all cash flows
if interest is homogeneous with time
(which is the usual assumption)
60/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
61/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
62/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
63/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
f (in )
f (in )
in+1 = in
in in+1
f (in )
64/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Relation between Cash Flow, Interest and Present Value
65/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Annuities: Introduction
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
66/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Annuities: Introduction
Notation
66/90
(p)
ax:n i
m|
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Annuities: Introduction
67/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Annuities: Introduction
68/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Annuities: Introduction
Numerical example
69/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
70/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
70/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
71/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
72/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
73/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
Deferred annuity
74/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
75/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
76/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
77/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
an i =
where j = (1 + i)1/p 1.
78/90
1
anp
p
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
79/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Term Annuities
Numerical example
80/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
Plan
Module 1: Time Value of Money and Valuation of Cash Flows
Cash Flow Models
A Mathematical Model of Interest
Simple and Compound Interest
Discount Interest
Nominal Interest
Force of Interest
Real and Money Interest
Relation between Cash Flow, Interest and Present Value
Annuities: Introduction
Term Annuities
Non-Level Annuities
81/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
81/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
82/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
83/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
84/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
85/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
86/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
87/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
88/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
Decreasing annuity
89/90
Financial Mathematics
Module 1: Time Value of Money and Valuation of Cash Flows
Non-Level Annuities
90/90