Time Value of Money

Present Value of a single payment of CT to be received in T periods when

the interest rate is r:
CT
PV
(1 r ) T
Future Value of cash flow C0 to be invested over T periods when the
interest rate is r:
FV C 0 (1 r ) T

Present Value of multiple payments Ci where i = 1,,T when the interest

rate is r:
C1
C2
CT
PV

...
2
(1 r ) (1 r )
(1 r ) T

Present Value of an Annuity payment C that lasts for T periods whenthe

interest rate is r:
1
1
PV C 1
r
(1 r ) T

Future Value of an Annuity payment C that lasts for T periods whenthe

interest rate is r:
(1 r ) T 1

FV C

Present Value of a Perpetuity of C that lasts forever when the interest rate
is r:
PV

C
r

Bond Prices and Yields

Price of a bond that makes fixed coupon payments of C, maturity of T,
yield-to-maturity of y, and a face value of FV:
T

P
t 1

C
FV

t
(1 y )
(1 y ) T

 Realized Compound Return is the compound rate of growth of invested

funds, assuming all interim cash flows are reinvested. Let the initial value
of the investment be V0, its terminal value VT , and the holding period T.
Then r is the realized compound return.
V0 (1 r ) T VT

Holding Period Return (HPR) is the total realized return achieved from an
investment, including any cash flows and any changes in value during an
investor's holding period. Let the initial price of the security be P0, and
the final price PT. HPR is given by:
HPR

PT P0 Cash Flows
P0

Forward rate for period n is defined as the short rate starting at period n
that is implied by the spot rates.

(1 y n ) n
(1 f n )
(1 y n 1 ) n 1

Duration and Sensitivity of Bond Prices to Interest Rate Changes

The duration of a bond is defined as the weighted average of the times to
the cash flows of the bond. The weights are given by the proportion of
each payment to the total.
T

D t wt where wt
t 1

PV (CFt )
P0

Duration of a perpetuity:
D

1 y
y

The proportional change in a bonds price can be related to the change in

its yield using duration.
P
D

y
P
1 y

 Duration combines linearly. Duration of a portfolio is the weighted

average of the durations of the individual securities in the portfolio.
N

D p wi Di
i 1