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Selected Financial Formulae

Purpose Formula

Basic Time Value Formulae

Future Value of a Single Sum FV = PV ( 1 + i ) N
Present Value of a Single Sum FV -
PV = ------------------
( 1 + i)N
Solve for N for a Single Sum FV
ln ⎛⎝ -------⎞⎠
PV
N = ---------------------
ln ( 1 + i )
Solve for i for a Single Sum FV
i = N ------- – 1
PV
Present Value of an Ordinary Annuity 1 – 1 ⁄ ( 1 + i )N
PV A = Pmt -----------------------------------
i

Future Value of an Ordinary Annuity ( 1 + i)N – 1

FV A = Pmt ----------------------------
i

Present Value of an Annuity Due 1 – 1 ⁄ ( 1 + i )(N – 1)

PV Ad = Pmt --------------------------------------------- + Pmt
i

Future Value of an Annuity Due ( 1 + i )N – 1

FV Ad = Pmt ---------------------------- ( 1 + i )
i

Present Value of an Annuity Growing at a Pmt 1 1+g N

Constant Rate (g) PV GA = ------------ ⎛ 1 – ⎛ ------------⎞ ⎞
i–g⎝ ⎝ 1 + i⎠ ⎠

Future Value of an Annuity Growing at a Pmt 1 1+g N

FV GA = ------------ ⎛ 1 – ⎛ ------------⎞ ⎞ ( 1 + i )
N
Constant Rate (g) i–g⎝ ⎝ 1 + i⎠ ⎠

Holding Period Return (single period)

P 1 + ∑ Cash Flows
HPR = ----------------------------------------------- – 1
P0

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 1

Selected Financial Formulae

Purpose Formula

Holding Period Return with Reinvestment

N
(for multiple sub-period returns)
HPR Reinvest = ∏ ( 1 + HPRt ) – 1
t=1

Basic Security Valuation Formulae

Dividend Discount Model (AKA, the Gordon D0 ( 1 + g ) D1
Model) V CS = -----------------------
- = ----------------
-
k CS – g k CS – g

Two-stage Dividend Discount Model D0 ( 1 + g1 ) 1 + g1 n

Notes: This equation is too long for one line. V CS = -------------------------- 1 – ⎛⎝ -----------------⎞⎠
k CS – g 1 1 + k CS
g1 = Growth rate during high growth phase.
n
g2 = Growth in constant growth phase after n. D0 ( 1 + g1 ) ( 1 + g2 )
-------------------------------------------------
n = Length of high growth phase. k CS – g 2
Assume g1 <> kCS and g2 < kCS + -------------------------------------------------
n
( 1 + k CS )

Three-stage Dividend Discount Model

Notes: D0 n1 + n2
n1 = Length of high growth phase. V CS = ------------------- ( 1 + g 2 ) + ----------------- ( g 1 – g 2 )
k CS – g 2 2
n2 = Periods until constant growth phase.
n2 = n1 + length of transistion phase.

Earnings Model
RE 1 ⎛ ROE ------------ – 1⎞
EPS ⎝ k CS ⎠
V CS = ------------1- + ------------------------------------
-
k CS k CS – g

Constant Growth FCF Valuation Model FCF 1

VOps = Value of Total Operations V Ops = ----------------
-
k CS – g
VDebt, VPref = Value of debt and preferred stock
VNon-Ops Assets = Value of non-operating assets V CS = V Ops – V Debt – V Pref + V Non – OpAssets

Sustainable growth rate g = br

Note: b = retention ratio = 1 - payout ratio
r = return on equity
Value of a Share of Preferred Stock D-
V P = ----
kP

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 2

Selected Financial Formulae

Purpose Formula

Value of a Bond on a Payment Date 1 – 1 ⁄ ( 1 + kd )N FV -

V B = Pmt -------------------------------------- + ---------------------
kd ( 1 + kd )N

Quoted Price of a Bond on a Non-Payment α

V B, α = V B, 0 ( 1 + k d ) – α ( Pmt )
Date
VB,0 = Value of bond at last payment date
α = The fraction of the current period that has elaspsed

Basic Statistical Formulae

Arithmetic Mean (Average)
1 N
X = ----
N ∑
t=1
Xt

Geometric Mean (used for averaging returns, N

growth rates, etc.) G = N ∏ ( 1 + Rt ) – 1
t=1

Expected Value (Weighted Average)

N
E(X) = ∑ ρt Xt
t=1

Variance
2 N
∑ ρt ( Xt – X )
2
σX =
t=1

Standard Deviation 2
σX = σX

Covariance
N
σ X, Y =
t=1
∑ [ ρt ( Xt – X ) ( Yt – Y ) ]
Correlation Coefficient σ X, Y
r X, Y = ------------
-
σX σY

Beta (Note: M is the market portfolio, and i is σ i, M r i, M σ i σ M

the security or portfolio) β i = ----------
- = ----------------------
-
2 2
σM σM

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 3

Selected Financial Formulae

Purpose Formula

Portfolio Formulae
Expected Return of a Portfolio
N
E ( RP ) = ∑ wi Ri
i=1

Variance of a 2-security Portfolio Using the covariance:

2 2 2 2 2
σ P = w 1 σ 1 + w 2 σ 2 + 2w 1 w 2 σ 1, 2
or, using the correlation coefficient:
2 2 2 2 2
σ P = w 1 σ 1 + w 2 σ 2 + 2w 1 w 2 r 1, 2 σ 1 σ 2

Variance of an N-security portfolio Using the

2 N N
Covariance σP = ∑ ∑ w i w j σ i, j
i=1 j=1

σP = σP

Portfolio Beta
N
βP = ∑ wi βi
i=1

95% Value at Risk (Variance/Covariance VaR = 1.645 × V p × σ p

Model)
Note: Vp is portfolio value

Capital Market Theory Models

Capital Market Line (CML) ( E ( RM ) – Rf )
E ( R P ) = R f + σ P --------------------------------
σM

Capital Asset Pricing Model (CAPM) E ( Ri ) = Rf + βi ( E ( RM ) – Rf )

Note: This is also the equation for the Security
Market Line (SML)
Treynor’s Risk-adjusted Performance Ri – Rf
Measure T i = ---------------
-
βi

Sharpe’s Risk-adjusted Performance Measure Ri – Rf

S i = ---------------
-
σi

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 4

Selected Financial Formulae

Purpose Formula

Jensen’s Alpha αi = ( Ri – Rf ) – βi ( RM – Rf )

The Information Ratio RP – RB

IR P = ------------------
-
σ RP – RB

M2 (Modigliani & Modigliani) Performance σm

M = ⎛⎝ -------⎞⎠ ( R i – R f ) + R f
2
Measure σi

Fama’s Risk Decomposition Risk Premium = R i – R f

Notes:
Risk = β i ( R M – R f )
Ri = Portfolio Return
RM = Market Return Selectivity = Risk Premium – Risk
Rf = Risk-free Rate Managers Risk = ( β i – β T ) ( R M – R f )
βi = Portfolio Beta Investors Risk = β T ( R M – R f )
βT = Target Beta σ
Diversification = ⎛ ------i- – β i⎞ ( R M – R f )
⎝σ ⎠
M
Net Selectivity = Selectivity – Diversification
N
Notes:
At = ∑ ( w i, t – w i, t ) ( R i, t – R t )
i=1
At = Overall Allocation Effect
St = Overall Selection Effect N
It = Overall Interaction Effect
St = ∑ wi, t ( Ri, t – Ri, t )
i=1
wi,t = Weight of Sector i in portfolio t
bars over variables represent benchmark N
weights and returns. It = ∑ ( wi, t – wi, t ) ( Ri, t – Ri, t )
i=1

Options and Futures Valuation Models

Black-Scholes European Call Option – rt
C = SN ( d 1 ) – Xe N ( d2 )
Valuation Model
where:
S
ln ⎛ --- ⎞ + ( r + 0.5σ )t
2
⎝ X⎠
d 1 = ----------------------------------------------------
σ t
d2 = d1 – σ t

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 5

Selected Financial Formulae

Purpose Formula

Black-Scholes European Put Option P = Xe – rt N ( – d 2 ) – SN ( – d 1 )

Valuation Model (see above for d1 and d2)

Put-Call Parity for European Options with No C = P + S – Xe – rt

Cash Flows or,
P = C + Xe – rt – S
Single-period Binomial Option Pricing Model pC u + ( 1 – p )C d
for Call Options (r is the risk-free rate, u is the C = ---------------------------------------
(1 + r)
up factor, and d is the down factor)
where,
r – d-
p = -----------
u–d
Single-period Binomial Option Pricing Model pP u + ( 1 – p )P d
for Put Options P = --------------------------------------
-
(1 + r)
where,
r – d-
p = -----------
u–d
Cost of Carry Model for Pricing Futures = S 0 e CC ( t )
T F0
Contracts (CC is the carrying costs as a % of
the spot price)
Bond Analysis Formulae
Macaulay’s Duration on a Payment Date (for
immunization). Note: Ct is the cash flow in
N Ct ( t )
period t, i is the yield to maturity
∑ (----------------
1 + i)t
-
t=1
D = ---------------------------
Bond Price
Modified Duration (for price volatility) on a D
D Mod = ---------------
Payment Date (1 + i)
Convexity on a Payment Date
1 - N 2 Cf t
( 1 + i ) 2 t∑
----------------- ( t + t ) ----------------
-
=1 ( 1 + i ) t

C = ---------------------------------------------------------------------
Bond Price
The n-period forward rate given two spot rates i
(note that i > j, and n = i - j) ( 1 + Ri )
t + jRn = n --------------------
j
( 1 + Rj )

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 6

Selected Financial Formulae

Purpose Formula

Bank Discount Yield for discount securities FV – PP 360

(FV = face value, PP = purchase price, m = BDY = --------------------- × ---------
FV m
periods per year)
Bond Equivalent Yield for discount securities FV – PP 365 FV 365
(see definitions for BDY) BEY = --------------------- × --------- = BDY × ------- × ---------
PP m PP 360

Capital Budgeting Decision Formulae

Net Present Value (NPV)
N Cf t
NPV = ∑ -----------------t – IO
t = 1 (1 + i)

Profitability Index (PI)

N Cf t
∑ -----------------
t = 1 (1 + i)
t
PI = --------------------------- = NPV + IO- = NPV
------------------------ ------------ + 1
IO IO IO
Internal Rate of Return (IRR). Note: This is a
trial and error procedure to find the i that
N Cf t
makes the equality hold (i.e., what discount
0 = ∑ ----------------- – IO
t = 1 (1 + i)
t
rate makes the NPV = 0).
Modified Internal Rate of Return (MIRR). N (N – t)

t=1
Cf t ( 1 + i )
N
MIRR = ---------------------------------------------- – 1
IO
Stock Market Index Construction Formulae
Price-weighted Average (e.g., DJIA) N
Note: The divisor (Div) at period 0 is equal to ∑ Pj
the number of stocks in the average. It will be j=1
PWA t = --------------
adjusted for stock splits or any other corporate Div t
action that results in a non-economic change
in the stock price.
Capitalization-weighted Index (e.g., S&P
N
500)
Note: The divisor (Div) at period 0 is the
∑ Pj Qj
j=1
divisor that makes the initial level of the index CWI t = --------------------
Div t
equal to the desired starting point. It will be
adjusted for any corporate action that results
in a change in market capitalization.

Basic Financial Formulae © 1995-2008 by Timothy R. Mayes, Ph.D. 7

Selected Financial Formulae

Purpose Formula

Equally-weighted Arithmetic Index (e.g.,

VLA)
N P j, t ⎞
⎛ --------------
Note: At period 0 the index is set to some
EWAI t = EWAI t – 1 × ∑ ⎝ P j, t – 1⎠
- ⁄N
j=1
starting value (e.g., 100). To calculate the
index for any day, multiply the average %
change by the previous index level.
Equally-weighted Geometric Index (e.g., N P j, t
VLG) EWGI t = EWGI t – 1 ×
N ∏ Pj, t – 1-
--------------
Note: See note above j=1

Corporate Financial Formulae

Net Operating Profit After Taxes (NOPAT) NOPAT = EBIT ( 1 – t )
Net Operating Working Capital (NOWC) NOWC = Op. C.A. – Op. C.L.
Operating Capital (Op. Cap.) Op. Cap. = NOWC + NFA
Free Cash Flow (FCF) FCF = NOPAT – Net Investment in Op. Cap.
Economic Value Added (EVA) EVA = NOPAT – ( Op. Cap. × Cost of Cap. )
Beta of a Leveraged Firm βL = βU [ 1 + ( 1 – t ) ( D ⁄ S ) ]

Merton Value of Firm with Personal Taxes ( 1 – tC ) ( 1 – tS )

V L = V U + 1 – ------------------------------------
-
( 1 – tD )

Miscelaneous Formulae
Margin Call Trigger Price IM% – 1
P M = ------------------------ × P 0
Note: IM% is the initial margin supplied, MM% – 1
MM% is the maintenance margin
requirement, P0 is the initial value of the
portfolio
Percentage gain to recover (% GTR) from a 1 -–1
loss (%L) %GTR = ----------------
1 – %L