( ) [ ]

1. Introduction and Time Value of Money ny 5. Geometric Gradient: CF of mag. A in period 1 that grows at a rate G
r n /m %
I 1.11 General Formula: r y/ y = 1+ −1 from period 2 to N: CF=A ¿
1.1 Interest Rate: i= nm period Mathematically Equivalent: If all PW are calculated with the same
P annual interest, then they are mathematically equivalent.
-P: Principle amount L [m]
n m=
- : # of compounding periods n in time m . 1
-I: Total interest amount
L[n] 2.3 Invertibility: (X /Y , i , N )=
1.2 Future Amount with Simple Interest: F N =P(1+¿) (Y / X ,i , N)
L[ y ] 2.4 Compound Amount Factor:
-FN: Future amount in (time unit) N -n = : # of compounding periods n per year.
y
-N: Number of periods L[n] F=P(F / P ,i , N )=P ( 1+i )
N
-Key: Applies only to P. -Length L must be in the same units. r t
-If CC: (F /P ,i , N )=e
F N =P ¿
cc
ny
1.3 Future Amount with Compound Interest (CI): r
-If n / n, then r
y/ y =( 1+r ) −1
n /n
(i.e. don’t need to divide
2.5 PW Factor:
-Key: Applies to P and interest already accrued.
since it’s already the int. rate per compounding period).
r 1.12 Process for Finding Equivalent Interest Rates
P=F (P/ F ,i , N )=F ¿
1.4 Subperiod Interest Rate: s i= 1. Assume CI, any rate to be per year, and interest being compounded 1
m once per period unless stated otherwise. -If CC: (P/ F ,i , N )=
r t
-r: Nominal interest rate
2. Identify variables with values using r x/ y notation. e cc

-m: Number of times compounded (subperiods) per year 2.6 Series Compound Amount Factor:
r x/ y r y/ y equal to each other using the general formula or CC
( )
1.5 Notation: 3. Set
( 1+i )N −1
-x: How much is interest compounded? version. F= A( F / A , i, N )= A
-y: How long of a period? 4. Solve for the unknown interest. i
1.6 Effective Interest Rate:
y/ y r
e =i =( 1+i ) −1
s
m
5. SC of r y/ y: Given two rates for a duration t 2−t 1, then 2.7 Sinking Fund Factor:
A=F( A / F , i, N )= A ¿
( )( )
n n
1.7 Continuous Compound (CC) Interest Over 1 Year: r n /m t1
rn / m n
t2

1+ 1+ =( 1+r y / y )
( mr ) −1=e −1
m
rcc
t 1 +t 2
A
r =i = lim 1+ nm nm 2.8 PV of a Perpetuity: P=
y/ y e
i

( )
m →∞ nt
r n /m
[ ]
1
2.9 Series PW Factor:
rcc t % 1+ e r t =( 1+r y/ y )n
cc 2 t 1 +t 2
|
P= A ( P/ A , i, N )= A ¿
1.8 CC Over t years: i e =e −1 r ; cc nm
year -Assume: Annuity starts in period 1. If not, then discount using P/ F
rcc t 1 r cc t 2 nt + t
t [ year ]
- e e =( 1+r y / y ) 1 2

to period 0.
4 [Q] L[ t 1] 2.10 Capital Recovery Factor:
-Note: Can convert into other units: t [ y ]⋅ =4 t [Q], so nt =
- : # of compounding periods n in time t 1. A=P( A/ P , i, N )=P ¿
[ y] 1
L[n] 2.11 PV of Arithmetic Gradient:

r
then cc
[ %
quarters ] nt =
-
2
L[n]
L[ t 2]
: # of compounding periods n in time t 2.
P= A (P/ A , i, N )+ G(P/G ,i , N )=A (P/ A , i, N )+G
A (constant) starting at t=1
-Initial annuity
1.9 Future Amount with CI with Subperiods Over 1 Year: -G (grows arithmetically) starting at t=2
m rcc L [ t 1+t 2 ]
F=P ( 1+i ) =P ( 1+r
s y/ y )=P e [$] -n
t +t = : # of compounding periods n in time t 1+ t 2. -Assumes no cash-flow at time 0 .
1.10 Future Amount with CI with Subperiods Over t Years:
1 2
L[n] 2.12 PV of Geometric Series:

( )
mt t rcc t 2. Cash-flow Diagrams and Equivalence
F=P ( 1+i ) =P ( 1+i ) =P e
( )
N
s e 1+ g
2.0 CF Diagrams 1−
-Note: Can convert into other units.
A 1+i
( P / A ,i 0 , N )= A
X-Axis: Discrete time periods | Y-Axis: Size and direction of cash-flow.
-Careful: If given months, must convert to years for t: Assumptions: P=
a months a 1. End of one period is the beginning of the next. 1+ g 1+ g i−g
= [ y] 2. PW: Time 0
12 months 12 1
3. Cash-flows: Happens at the end of the period. -(P/Geom , i , g , N )= ( P/ A , i0 , N );
1y 4. Interest: Compounded once per period, so you need r x/ x to be in 1+ g
1+i
ln(F /P)
( )
1/ t the same compounding period x.
-Note: Can find r cc =
F i=
o
−1
∨r y / y = −1 2.1 Types of Cash Flows
1+ g
t P 2. Perpetuity: CF of mag. A that occurs at regular intervals forever.
3. Annuity: CF of mag. A that occurs at regular intervals for N periods -Initial annuity A (constant) at t=1
starting in period 1. -g at t=2
4. Arithmetic Gradient: CF of mag. A in period 1 that grows
2.13 Process for CF Analysis:
incrementally with mag. G from period 2 to N:
1. Draw CF diagrams (part marks)
CF=A +(N −1)G 2. Identify variables with corresponding values.
3. Find interest rates that are in terms of the periods in the CF diagrams. 3.3 Coupon Payment 5. Determine P
new ,1 with this CR
4. If finding PV, make sure to discount values using P/ F . Face Value 6. Calculate total received by
CP=Coupon Rate ×
-Note: (X /Y )=(Z /Y )( X /Z ) Payment Frequency Total=Pnew , 1 ⋅¿ bonds ⋅(1−FF %)
3. Cash-flow Analysis: Bonds 3.4 Yield: 4. Risk, Reward, and Arbitrage
3.0 Net Periodic Payment (Usually Months) Hypothetical interest rate of a bond given a purchase price usually Process for FX Arbitrage (Boxed Diagram)
A=P ( A / P ,r N / N , tN )=P ¿ r s/ y 1. Given some C 1, C 2, F X 0 , F X 1 , r f ,r f
1 2
-P: Mortgage principal (i.e. how much you have to finance) -If BP and FV are the same and years to maturity align with CP
frequency, then yield equals CR. 2. Start with C 1=1 (top left), apply F X 0 ⋅C 1=C 2 to obtain
-A: Regular mortgage payment for a payment period
3.5 Bond Price
-r N / N : Rate (number of payment periods per year) for current term C 2 (bot. left).

[ ] [ [ ]]
N
( 1+ r ) −1 1
(usually r m / m).
F0 has units of CN 2 .
N / N
P0= A ( P 0 / A ,r N / N , N ) + F ( P 0 /F , r N / N , N ) = A -AssumesN F+X
-N: Number of payment periods per year.
-t: Number of years in amortization (or what is left)
r N / N ( 1+ r N / N ) ( 1+ r N / N C
) 1
-Mortgage rate: Usually r s/ y . -r N / N : Rate in terms of periods N (obtained from the yield) 3. Find C 1 ,1=C 1 ( 1+r f ) , C 2 , 1 ¿ C 2 ( 1+ r f ) respectively
1 2
3.1 New principal owed at end of term: -Key: r N / N has to be in the same frequency as A, but for F, it can (top/bot. right).

[ ]
tN
be any rate as( 1+r
N/N)
long as periods −1
match. C 1 ,1
tN
Pnew =P ( F / P ,r N / N , tN )− A ( F / A , r N / N , tN )=P ( 1+r N / N-N:) Number
− A of periods to maturity (match CP period). 4. F X =
1
-A: Value of couponrpayment.
N/N
C 2 ,1
-F: Face value 5. Determine unknown using the boxed diagram and relationships.
-P: Mortgage principle
3.6 Process for Calculating Bond Prices
-A: Regular mortgage payment for a payment period
0. Assume all coupons are paid semi-annually and the payment is half
r :
- N / N Interest (number of payment periods per year) for previous the coupon rate.
1. Assume all yields are annual rates with compounding matching
r
term (usually m / m).
coupon payment frequency.
N: Number of payment periods per year. 1. Draw CFs (if offset x, then set x s.t. last coupon payment and face
t: Number of years in previous term.
3.2 Process for Calculating Payments Per Certain Period
value at time lengthN + x ).
0. Assume mortgage rate is r s/ y unless stated otherwise.
-Use ¿ [ years]−¿[months ] notation for payments if 4.0 CAPM Model:
1. Identify the principle, mortgage rate, and amortization period and
necessary.
2. Identify yield, N, F, and calculate CP.
E [ RC ]=r f + β c ( E [ Rmp ]−r f )
draw CF.
2. Convert mortgage rate to be in terms of the periods you want: r N/N 3. Convert yield to appropriate rate: r N/N - E [ RC ] : Expected rate of return for a company (assume r y/ y ¿
3. Change amortization to be the appropriate periods: tN 4. If CP frequency matches bond maturity, then find P
0 -r f : Risk-free rate
5. Assume CP is not immediate, unless stated otherwise. If it’s
4. Use the net periodic payment formula. - β c : Measure of risk for the company, systematic risk, related to
5. For another term’s periodic payment, calculate a new principle based P0 .
immediate, then add a single CP to
market risk
on the previous’ term interest rate.
6. Repeat 1-4, 5 (optional) with new term’s interest rate, and remaining 6. Otherwise, findP−x if offset: - E[R ]:
mp Expected rate of return of the market portfolio, represents
amortization. P0=P−x ( F /P , r N / N , x ) the whole market.
7. Break-Even Penalty SC: To switch from one mortgage to another, the 4.1 Process for CAPM Model
X pen s.t. -Assume r N / N and x have matching periods.
break-even fee is when same periodic payments, so find 1. Identify r f , β c , E [ R mp ] , P , D % (i.e. dividend) and draw
3.7 Process for Finding the Yield (i.e. Interpolation)
A prev =( Pnew + X pen ) ( A /P , r N / N , new , tN ) 1. Input equation on calculator with the unknown variable x and = to CF

tN : Number of payment periods left (what is left in amortization).

- equate LS/RS. 2. Find E [ Rc ]=r y/ y using the CAPM model.
2. Use “solve” on the calculator.
Mortgage Switching:
3. Press “=” to compute the value. 3. Find F 1, tot =P ( 1+r y / y ) .
1. Identify mortgage rate, principle, and amortization period for M1
2. Find net periodic payment of M1 i avg−i 1 i 2−i 1 -Note: F 1, tot =F 1 if there is no dividend.
P1=P ⋅ X % and find net periodic payment 3.8 Interpolation: =
3. For M2, compute
P avg−P1 P 2−P1 4. If dividend, remove dividend from F 1=F1 , tot ( 1−D %).
using the discounted mortgage unless it’s given. 3.9 Financing Projects Using Bonds
-Key: Term acts like the amortization of being at this discounted rate. 5. Repeat steps 3-4 with P=F 1 for year 2 and so on.
1.Identify total cost, old/new bond variables.
4. Compute the new principal using the mortgage rate of M1 to be a fair 2. Find yield using the old bond. A
price for M2. 4. SC: If perpetuity: P=
Total Cost r y/ y
5. Compute the unknown net periodic payment using the mortgage 3. Pnew = /(1−FF % ). If financing fee
rate of M1. ¿ Bonds
involved, apply denom.
4. Find the CR for new bond and round up to nearest increment.
4.1 Beta: -a: Number of MP shares
σ i , MP ❑ σi -b: Number of risk-free shares/bonds/etc.
β i= 2
=ρi , MP 3. Calculate fair market value: P I =a ⋅ P MP +b ⋅ Pr
σ MP σ MP
E [ RI ] −r f
-σ i ,MP : Covariance between ith company and market portfolio (MP) 4. Calculate β=
-σ
2 E [ RMP ]−r f
MP :
Variance of MP

- ρ i , MP : Correlation of returns between ith company and MP -

E [ R MP ] =P P MP−¿(X−1) ¿
MP+¿ X + −1 ¿
PMP
-σ i: Volatility of ith company
E [ R I ]=P PI −¿( X−1) ¿
-σ MP : Volatility of MP - I+¿ X + −1¿
PI
4.2 Meaning of Beta (M - Market, I - Investment, VV - Vice Versa)
- β=1: Moves in same dir. with M ( M ↑ , I ↑, VV) 5. SC: If given P I , P I+¿ , P ¿, repeat steps 1-3, but compare
I−¿¿

- β >1: More risky than M in the same dir. ( M ↑ , I ↑ ׿ , VV) P I ,calc with P I ,given to determine if given P I is priced correctly.
-0< β <1 : Less risky than M in the same dir. ( M ↑ , I ↑ ÷ ¿, VV) -If P I ,given > P I , calc, then do not buy at P I ,given . Otherwise, buy.
-−1< β <0 : Less risky than M in opp. dir. to M ( M ↑ , I ↓ ÷ ¿, 6. SC: If not given r f , set up system of 3 equations for P , P +¿, P ¿
−¿ ¿
VV)
with a , b , r f as unknowns using the other two assets (i.e. step 2-3).
-β ←1: More risky than M in opp. dir. to M ( M ↑ , I ↓ ׿ ,VV)
-β=−1: Moves in opp. dir. with M ( M ↑ , I ↓, VV) P1+¿ a+ P ¿
2+ ¿b=1⋅ (1+ rf )¿

4.3 Forward Rate Assuming CC: The interest rate t 1 away from t=0 P1−¿a +P ¿
2−¿b=1 ⋅(1+ r f) ¿

for a duration of t 2−t 1 is P1 a+ P2 b=1

r 0 ,t ⋅t 2−r 0 ,t ⋅t 1 -Bring r f to LS and use simultaneous equations on Casio.
r t ,t = 2 1

7. SC: Given market portfolios for two countries, assuming 100 %

1 2
t 2−t 1
correlation, then P MP ±, C =PMP ± ,C F X 0 , where
-r 0 , t : Rates for investments between t=0 to t=t 1 1 2

[ ]
1

-r 0 , t : Rates for investments between t=0 to t=t 2 C1

2 F X0 to get the other diagram in terms of the same currency.
4.4 Forward Rate Assuming Effective: C2

( )
t2 1
( 1+r 0 , t ) t 2−t 1
4.5 Process for Replication of Bonds
r t ,t = −1 1. Given CR, years to maturity X, risk-neutral probability (RN), risk-free
2

t
1 2
( 1+r 0 ,t )1
1
rate r
f.
2. Draw CF up/down diagrams up to year X
4.5 Process for Replication of Portfolio:
1. Draw the following: -Year 0: Includes only the bond price, P0 .
-Market: P MP with probability X of P MP+¿ ¿ and with probability of -Down arrow: RN % as an edge with value being the consequence
given.
1− X of P MP−¿¿.
-Up arrow: 1−RN % as an edge with value being CP. At year X,
-Project: P I =? with P I+¿ ¿ and P I−¿¿.
receive final CP and FV if up arrow.
-If P I+¿/ P ¿ have different payoffs based on the market going up
3. Calculate

E [P ]
I−¿¿
( X) (X ) (X )
w/ probability Y or down with probability 1−Y , then calculate (X −1) P ⋅ RN % + Pdown ⋅(1−RN % )
P up =CP+ =CP+ up
expected price:
(1+r ) f ( 1+r f )
● E ¿. -i.e. sum of CP and expectation of bond price at year X discounted by 1
● E ¿. year.
(1 )
-Risk-free: Pr =1 with Pr +¿=1 ⋅ 1+r ¿ and Pr −¿=1 ⋅ 1+ r ¿ . 4. Repeat step 4 until P .
( ) ( ) f f up
2. Replication of portfolio: Same risk-value as the project (solve for a 5. Calculate

E [ P ] P ⋅ RN %+ P ⋅(1−RN %)
and b): (1) (1) (1)
up down
+: a P MP +¿+ b P ¿ P= 0 =
r + ¿=P I +¿ ¿ ¿
(1+r ) f (1+ r ) f
−:a P MP−¿+b P
6. Use P0 to find yield using bond equation.
r−¿=PI −¿ ¿ ¿ ¿