Business Finance

Amortization of loan (Death of Loan):

In banking and finance, an amortizing loan is a loan where the principal of
the loan is paid down over the life of the loan (that is amortized) according to
an amortization schedule, typically through equal payments.

Amortization Calculation:
Usually, whether you can afford a loan depends on whether you can afford
the periodic payment (commonly a monthly payment period). So, the most
important amortization formula is probably the calculation of the payment
amount per period.

Calculating the Payment Amount per Period

The formula for calculating the payment amount is shown below.

Simple Amortization Calculation Formula

where
A = payment Amount per period
P = initial Principal (loan amount)
r = interest rate per period
n = total number of payments or periods

Example: Loan amortization:

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Suppose you want to borrow money to buy a house. You are considering a
15-year or a 30-year loan. The lender offers different interest rates, reflecting
the differences in risks of shorter-term and longer-term lending. For the 15year loan, the annual rate is 6.25% (compounded monthly, with 180 equal
monthly payments). For the 30-year loan, the annual rate is 6.75%
(compounded monthly, with 360 monthly payments). If you borrow
$150,000, what would your monthly payments be for each loan?
Answer:
What is the stream of payments necessary to pay off an increasing sum? Use
the present value formula to calculate the present value of Pymtn deposited
at the end of n periods discounted at i percent:
PV = Pymtn * [(1+i)n - 1] / (1+i)n * i
Solve for Pymtn for the 15-year loan:
PV = Pymtn * [(1+i)n - 1] / (1+i)n * i
Pymt180 = $150,000 / [(1+.0625/12)180 - 1] / [(1 + .0625/12)180 * .
0625/12]
Pymt180 = $1,286.13

Risk and Returns:

The principle that potential return rises with an increase in risk. Low levels of
uncertainty (low-risk) are associated with low potential returns, whereas high
levels of uncertainty (high-risk) are associated with high potential returns.
According to the risk-return tradeoff, invested money can render higher
profits only if it is subject to the possibility of being lost.

Standalone Risk:

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The risk associated with a single operating unit of a company or asset.

Standalone involves the risks created by a specific division or project, which
would not exist if operations in that area were to cease.
Most investors do not hold stocks in isolation. Instead, they choose to hold a
portfolio of several stock are like shares, bonds, and other securities . When
this is the case, a portion of an individual stock's risk can be eliminated, i.e.,
diversified away. First, the computation of the expected return, variance, and
standard deviation of a portfolio must be illustrated.

Return:
Income received on an investment plus any change in market price, usually
expressed as a percent of the beginning market price of the investment.

R=
Pt-1

Pt= Current Price

Pt-1= Original price
Dt= Dividend

Dt + (Pt - Pt-1 )

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Example:
The stock price for Stock A was $10 per share 1 year ago.

The stock is

currently trading at $9.50 per share and shareholders just received a $1

dividend. What return was earned over the past year?

$1.00 + ($9.50 - $10.00 )

$10.00

R=

R= $1.00+ ($-o.5)
$10
R= $0.5/$10
R= $0.05*100= 5%
Risk:
The variability of returns from those that are expected.

Expected Return:

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The amount one would anticipate receiving on an investment that has

various known or expected rates of return.
For example, if one invested in a stock that had a 50% chance of producing
a 10% profit and a 50% chance of producing a 5% loss, the expected return
would be 2.5% (0.5 * 0.1 + 0.5 * -0.05). It is important to note, however, that
the expected return is usually based on historical data and is not
guaranteed.

R = ( Ri )( Pi )
R is the expected
return for the
asset,
Ri is the returnThe
for the ith expe
cted
possibility, retur
Pi is the n, R,
for
probability ofStock
that return BW is
occurring, .09 or

How to Determine the Expected Return and

Deviation:

9%

Standard

n is the total
number of
possibilities.
Stock BW

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Ri

Pi

(Ri)(Pi)

-.15
.10
-.015
-.03
.20
-.006
Stock
BW
.09
.40
.
Ri Pi
(Ri)(Pi)
036
2
(R
R
)
(Pi)
.21 i
.20
.
042 -.15
.10
Standard
Deviation:
.33 .00576
.10
.
-.015
033 -.03
.20
Sum
1.00
-.006
.00288 .
090 .09
.40

In finance, standard deviation is applied to the annual rate of return of an

investment to measure the investment's volatility. Standard deviation is also
known as historical volatility and is used by investors as a gauge for the
amount of expected volatility.

Determining Standard Deviation (Risk Measure):

.036
.00000
.21
.20
.042
.
00288
.33
.10

.033
.00576
Sum
1.00
.090
.01728
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( Ri - R )

( Pi )

.01728

Coefficient of Variation:

A statistical measure of the dispersion of data points in a data series around

.1315 or
13.15%

the mean. It is calculated as follows:

The coefficient of variation represents the ratio of the standard deviation to

the mean, and it is a useful statistic for comparing the degree of variation
from one data series to another, even if the means are drastically different
from each other.

The ratio of the

standard
deviation of a
distribution to

the mean of
that
distribution.
It is a measure
of RELATIVE
risk.

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CV = / R
CV of BW = .
1315 / .09 =
1.46