TIME VALUE OF MONEY

A. NOTATIONS
• T = Number of Years
• R = Annual Interest Rate
• m = Number of Periods Per Year or Number of Compounding Periods
• n = Number of Periods
𝑛 = 𝑇×𝑚
• r = Interest Rate Per Period
𝑅
𝑟=
𝑚
B. SINGLE CASH FLOWS:
• Future Value of a Single Cash Flow:
FVn = PV×(1 + r)n
where
(1 + 𝑟)𝑛 = 𝐹𝑉𝐼𝐹𝑛.𝑟
• Present Value of a Single Cash Flow:
FVn
PV =
(1 + r)n
where
1
= 𝑃𝑉𝐼𝐹𝑛.𝑟
(1 + 𝑟)𝑛
• Solving for a Rate (Single Cash Flow):
1
n
FVn n
r ⟹ FVn = PV×(1 + r) ⟹ r = ( ) −1
PV
• Solving for Number of Periods (Single Cash Flow):
FV
ln ( PVn )
n
n ⟹ FVn = PV×(1 + r) ⟹ n =
ln⁡(1 + r)
• Rule of 70:
70 70
n≈ ⟺r≈
r×100 n×100
• Rule of 72:
72 72
n≈ ⟺r≈
r×100 n×100
• Future Value Using Continuous Compounding
FV = PV×eR×T
• Present Value Using Continuous Compounding
FV
PV = FV×e−R×T = R×T
e
• APR vs. EAR
• EAR
APR m
EAR = (1 + ) −1
m
EAR = eAPR − 1
 • APR
APR = [(1 + EAR)1/m − 1]×𝑚
APR = ln⁡(1 + EAR)
C. MULIPLE CASH FLOWS
NOTE:
• Future⁡Value = Present⁡Value×(1 + r)n
• Value⁡of⁡Due = Value⁡of⁡Ordinary×(1 + r)
C.1. GENERAL CASE-UNEVEN CASH FLOWS
• Present Value of Multiple Cash Flows:
n
CF0 CF1 CF2 CFn−1 CFn CFt
PV = 0
+ 1
+ 2
+ ⋯+ n−1
+ n
=∑
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r) (1 + r)t
t=0
OR
n
CF1 CF2 CFn−1 CFn CFt
PV = CF0 + 1
+ 2
+ ⋯+ n−1
+ n
=∑
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r)t
t=0
• Future Value of Multiple Cash Flows:
FV = CF0 (1 + r)n + CF1 (1 + r)n−1 + CF2 (1 + r)n−2 + ⋯ + CFn−1 (1 + r)1 + CFn (1 + r)0
n n
n−t
CFt
= ∑ CFt (1 + r) = (∑ ) ×(1 + r)n = 𝑃𝑉×(1 + r)n
(1 + r)t
t=0 t=0
OR
FV = CF0 (1 + r)n + CF1 (1 + r)n−1 + CF2 (1 + r)n−2 + ⋯ + CFn−1 (1 + r)1 + CFn
n n
n−t
CFt
= ∑ CFt (1 + r) = (∑ ) ×(1 + r)n = 𝑃𝑉×(1 + r)n
(1 + r)t
t=0 t=0
• Solving for a Rate (Multiple Cash Flows)
(1) From Present Value
n
CF0 CF1 CF2 CFn−1 CFn CFt
r ⟹ ⁡PV = 0
+ 1
+ 2
+ ⋯+ n−1
+ n
=∑
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r) (1 + r)t
t=0
n
CF1 CF2 CFn−1 CFn CFt
⟹ ⁡PV = CF0 + 1
+ 2
+ ⋯+ n−1
+ n
=∑
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r)t
t=0
CF1 CF2 CFn−1 CFn
⟹ ⁡0 = −PV + CF0 + + + ⋯ + +
(1 + r)1 (1 + r)2 (1 + r)n−1 (1 + r)n
−PV + CF0 CF1 CF2 CFn−1 CFn
⟹ ⁡0 = + + + ⋯ + +
(1 + r)0 (1 + r)1 (1 + r)2 (1 + r)n−1 (1 + r)n
⟹ ⁡r = IRR
 (2) From Future Value
r ⟹ FV = CF0 (1 + r)n + CF1 (1 + r)n−1 + CF2 (1 + r)n−2 + ⋯ + CFn−1 (1 + r)1 + CFn (1 + r)0
n

= ∑ CFt (1 + r)n−t
t=0
⟹ FV = CF0 (1 + r)n + CF1 (1 + r)n−1 + CF2 (1 + r)n−2 + ⋯ + CFn−1 (1 + r)1 + CFn
n

= ∑ CFt (1 + r)n−t
t=0
⟹ 0 = CF0 (1 + r)n + CF1 (1 + r)n−1 + CF2 (1 + r)n−2 + ⋯ + CFn−1 (1 + r)1 + CFn − FV
CF1 CF2 CFn−1 CFn − FV
⟹ 0 = CF0 + 1
+ 2
+ ⋯+ n−1
+
(1 + r) (1 + r) (1 + r) (1 + r)n
CF0 CF1 CF2 CFn−1 CFn − FV
⟹0= 0
+ 1
+ 2
+ ⋯+ n−1
+
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r)n
⟹ ⁡r = IRR
C.2. LEVELED CASH FLOWS (NON-GROWING CASH FLOWS)
C.2.1 PERPETUITIES
• Present Value
• Ordinary (Present Value of Ordinary Perpetuity):
∞
PMT PMT PMT PMT PMT
PVP = + + ⋯ + = ∑ =
(1 + r)1 (1 + r)2 (1 + r)∞ (1 + r)t r
t=1
• Due (Present Value of Perpetuity Due):
∞
PMT PMT PMT PMT PMT
PVPD = PMT + 1
+ 2
+⋯+ ∞
=∑ t
= ×(1 + 𝑟)
(1 + r) (1 + r) (1 + r) (1 + r) r
t=0
• Solving for a Rate
• Present Value
• Ordinary (Present Value of Ordinary Perpetuity):
PMT PMT
r ⟹ PVP = ⟹r=
r PVP
• Due (Present Value of Perpetuity Due):
PMT
r ⟹ PVPD = ×(1 + 𝑟) ⟹ PVPD×r = PMT + PMT×r ⟹ (PVPD − PMT)×r = PMT
r
PMT
⟹r=
PVPD − PMT
• Solving for Payment
• Present Value
• Ordinary (Present Value of Ordinary Perpetuity):
PMT
PMT ⟹ PVP = ⟹ PMT = PVP×r
r
• Due (Present Value of Perpetuity Due):
PMT 𝑃𝑉𝑃𝐷×𝑟
PMT ⟹ PVPD = ×(1 + 𝑟) ⟹ PMT =
r (1 + 𝑟)
C.2.2 ANNUITIES
• Present Value
• Ordinary (Present Value of Ordinary Annuity):
n 1
PMT PMT PMT PMT 1−
(1 + 𝑟)𝑛
PVA = + + ⋯+ =∑ = PMT× [ ]
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t r
t=1

Where
1
1−
(1 + 𝑟)𝑛
[ ] = 𝑃𝑉𝐼𝐹𝐴𝑛.𝑟
r

• Due (Present Value of Annuity Due):

n−1 1
PMT PMT PMT 1 −
(1 + 𝑟)𝑛
PVAD = PMT + 1
+ ⋯+ =∑ = PMT× {[ ] ×(1 + 𝑟)}
(1 + r) (1 + r)𝑛−1 (1 + r)t r
t=0

Where
1
1−
(1 + 𝑟)𝑛
[ ] ×(1 + 𝑟) = 𝑃𝑉𝐼𝐹𝐴𝐷𝑛.𝑟
r

• Future Value
• Ordinary (Future Value of Ordinary Annuity):
n
n−1 n−2
FVA = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) + PMT = ∑ PMT(1 + r)n−t
1

t=1
(1 + 𝑟)𝑛 − 1
= PMT× [ ]
r
Where
(1 + 𝑟)𝑛 − 1
[ ] = 𝐹𝑉𝐼𝐹𝐴𝑛.𝑟
r
• Due (Future Value of Annuity Due):
n−1

FVAD = PMT(1 + r)n + PMT(1 + r)n−1 + ⋯ + PMT(1 + r)1 = ∑ PMT(1 + r)n−t

t=0
(1 + 𝑟)𝑛 − 1
= PMT× {[ ] ×(1 + 𝑟)}
r
Where
(1 + 𝑟)𝑛 − 1
[ ] ×(1 + 𝑟) = 𝐹𝑉𝐼𝐹𝐴𝐷𝑛.𝑟
r
• Solving for a Rate:
• Present Value
• Ordinary (Present Value of Ordinary Annuity)
n 1
PMT PMT PMT PMT 1−
(1 + 𝑟)𝑛
r ⟹ PVA = + + ⋯+ =∑ = PMT× [ ]
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t r
t=1

• Due (Present Value of Annuity Due)

n−1 1
PMT PMT PMT 1−
(1 + 𝑟)𝑛
r ⟹ PVAD = PMT + +⋯+ =∑ = PMT× {[ ] ×(1 + 𝑟)}
(1 + r)1 (1 + r)𝑛−1 (1 + r)t r
t=0

• Future Value
• Ordinary (Future Value of Ordinary Annuity)
n
n−1 n−2
r ⟹ FVA = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) + PMT = ∑ PMT(1 + r)n−t
1

t=1
(1 + 𝑟)𝑛 − 1
= PMT× [ ]
r
• Due (Future Value of Annuity Due)
n−1

r ⟹ FVAD = PMT(1 + r)n + PMT(1 + r)n−1 + ⋯ + PMT(1 + r)1 = ∑ PMT(1 + r)n−t

t=0
(1 + 𝑟)𝑛 − 1
= PMT× {[ ] ×(1 + 𝑟)}
r
• Solving for Number of Periods
• Present Value
• Ordinary (Present Value of Ordinary Annuity)
n 1
PMT PMT PMT PMT 1−
(1 + 𝑟)𝑛
n ⟹ PVA = + +⋯+ =∑ = PMT× [ ]
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t r
t=1

• Due (Present Value of Annuity Due)

n−1 1
PMT PMT PMT 1−
(1 + 𝑟)𝑛
n ⟹ PVAD = PMT + + ⋯+ =∑ = PMT× {[ ] ×(1 + 𝑟)}
(1 + r)1 (1 + r)𝑛−1 (1 + r)t r
t=0

• Future Value
• Ordinary (Future Value of Ordinary Annuity)
n
n−1 n−2
n ⟹ FVA = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) + PMT = ∑ PMT(1 + r)n−t
1

t=1
(1 + 𝑟)𝑛 − 1
= PMT× [ ]
r
 • Due (Future Value of Annuity Due)
n−1
n n−1
n ⟹ FVAD = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) = ∑ PMT(1 + r)n−t
1

t=0
(1 + 𝑟)𝑛 − 1
= PMT× {[ ] ×(1 + 𝑟)}
r
• Solving for Payment
• Present Value
• Ordinary (Present Value of Ordinary Annuity)
n 1
PMT PMT PMT PMT 1−
(1 + 𝑟)𝑛
PMT ⟹ PVA = + + ⋯+ =∑ = PMT× [ ]
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t r
t=1

• Due (Present Value of Annuity Due)

n−1 1
PMT PMT PMT 1−
(1 + 𝑟)𝑛
PMT ⟹ PVAD = PMT + 1
+ ⋯+ 𝑛−1
=∑ t
= PMT× {[ ] ×(1 + 𝑟)}
(1 + r) (1 + r) (1 + r) r
t=0

• Future Value
• Ordinary (Future Value of Ordinary Annuity)
n
n−1 n−2
PMT ⟹ FVA = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) + PMT = ∑ PMT(1 + r)n−t
1

t=1
(1 + 𝑟)𝑛 − 1
= PMT× [ ]
r
• Due (Future Value of Annuity Due)
n−1
n n−1
PMT ⟹ FVAD = PMT(1 + r) + PMT(1 + r) + ⋯ + PMT(1 + r) = ∑ PMT(1 + r)n−t
1

t=0
(1 + 𝑟)𝑛 − 1
= PMT× {[ ] ×(1 + 𝑟)}
r
C.3. GROWING CASH FLOWS
C.3.1 GROWING PERPETUITIES
• Present Value
• Ordinary (Present Value of Growing Ordinary Perpetuity):
∞
PMT PMT(1 + g) PMT(1 + g)∞−1 PMT(1 + g)𝑡−1 PMT
PVGP = + + ⋯ + = ∑ =
(1 + r)1 (1 + r)2 (1 + r)∞ (1 + r)t r−g
t=1
• Due (Present Value of Growing Perpetuity Due):
∞
PMT(1 + g) PMT(1 + g)2 PMT(1 + g)∞ PMT(1 + g)𝑡
PVGPD = PMT + + + ⋯+ =∑
(1 + r)1 (1 + r)2 (1 + r)∞ (1 + r)t
t=0
PMT
= ×(1 + 𝑟)
r−g
• Solving for a Rate
• Present Value
• Ordinary (Present Value of Growing Ordinary Perpetuity):
PMT PMT
r ⟹ PVGP = ⟹r= +𝑔
r−g PVGP
• Due (Present Value of Growing Perpetuity Due):
PMT
r ⟹ PVGPD = ×(1 + 𝑟) ⟹ PVGPD×r − PVGPD×g = PMT + PMT×r
r−g
PMT + PVGPD×g
⟹ (PVGPD − PMT)×r = PMT + PVGPD×g ⟹ r =
PVGPD − PMT
• Solving for Payment
• Present Value
• Ordinary (Present Value of Growing Ordinary Perpetuity):
PMT
PMT ⟹ PVGP = ⟹ PMT = PVGP×(r − g)
r−g
• Due (Present Value of Growing Perpetuity Due):
PMT 𝑃𝑉𝐺𝑃𝐷×(𝑟 − 𝑔)
PMT ⟹ PVGPD = ×(1 + 𝑟) ⟹ PMT =
r−g (1 + 𝑟)
C.3.2 GROWING ANNUITIES
• Present Value
• Ordinary (Present Value of Growing Ordinary Annuity):
n
PMT PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡−1
PVGA = + + ⋯ + = ∑
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t
t=1
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× [ ]
r−g

Where
1+𝑔 𝑛
1 − (1 + 𝑟 )
[ ] = 𝑃𝑉𝐼𝐹𝐺𝐴𝑛.𝑟,𝑔
r−g

• Due (Present Value of Growing Annuity Due):

n−1
PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡
PVGAD = PMT + +⋯+ =∑
(1 + r)1 (1 + r)𝑛−1 (1 + r)t
t=0
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× {[ ] ×(1 + 𝑟)}
r−g

Where
1+𝑔 𝑛
1 − (1 + 𝑟 )
[ ] ×(1 + 𝑟) = 𝑃𝑉𝐼𝐹𝐺𝐴𝐷𝑛.𝑟,𝑔
r−g
• Future Value
• Ordinary (Future Value of Growing Ordinary Annuity):
FVGA = PMT(1 + r)n−1 + PMT(1 + g)(1 + r)n−2 + ⋯ + PMT(1 + g)𝑛−2 (1 + r)1
n
𝑛−1
+ PMT(1 + g) = ∑ PMT(1 + g)𝑡−1 (1 + r)n−t
t=1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= PMT× [ ]
r−g
Where
(1 + 𝑟)𝑛 − (1 + g)𝑛
[ ] = 𝐹𝑉𝐼𝐹𝐺𝐴𝑛.𝑟,𝑔
r−g
• Due (Future Value of Growing Annuity Due):
FVGAD = PMT(1 + r)n + PMT(1 + g)(1 + r)n−1 + ⋯ + PMT(1 + g)𝑛−1 (1 + r)1
n−1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= ∑ PMT(1 + g)𝑡 (1 + r)n−t = PMT× {[ ] ×(1 + 𝑟)}
r−g
t=0
Where
(1 + 𝑟)𝑛 − (1 + g)𝑛
[ ] ×(1 + 𝑟) = 𝐹𝑉𝐼𝐹𝐺𝐴𝐷𝑛.𝑟,𝑔
r−g
• Solving for a Rate:
• Present Value
• Ordinary (Present Value of Growing Ordinary Annuity):
n
PMT PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡−1
r ⟹ PVGA = + + ⋯ + = ∑
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t
t=1
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× [ ]
r−g

• Due (Present Value of Growing Ordinary Due):

n−1
PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡
r ⟹ PVGAD = PMT + + ⋯ + = ∑
(1 + r)1 (1 + r)𝑛−1 (1 + r)t
t=0
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× {[ ] ×(1 + 𝑟)}
r−g

• Future Value
• Ordinary (Future Value of Growing Ordinary Annuity):
r ⟹ FVGA = PMT(1 + r)n−1 + PMT(1 + g)(1 + r)n−2 + ⋯ + PMT(1 + g)𝑛−2 (1 + r)1
n

+ PMT(1 + g)𝑛−1 = ∑ PMT(1 + g)𝑡−1 (1 + r)n−t

t=1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= PMT× [ ]
r−g
 • Due (Future Value of Growing Annuity Due):
r ⟹ FVGAD = PMT(1 + r)n + PMT(1 + g)(1 + r)n−1 + ⋯ + PMT(1 + g)𝑛−1 (1 + r)1
n−1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= ∑ PMT(1 + g)𝑡 (1 + r)n−t = PMT× {[ ] ×(1 + 𝑟)}
r−g
t=0
Solving for Number of Periods
• Present Value
• Ordinary (Present Value of Growing Ordinary Annuity):
n
PMT PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡−1
n ⟹ PVGA = + + ⋯ + = ∑
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t
t=1
1+𝑔 𝑛
1−( )
= PMT× [ 1+𝑟 ]
r−g

• Due (Present Value of Growing Annuity Due):

n−1
PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡
n ⟹ PVGAD = PMT + + ⋯ + = ∑
(1 + r)1 (1 + r)𝑛−1 (1 + r)t
t=0
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× {[ ] ×(1 + 𝑟)}
r−g

• Future Value
• Ordinary (Future Value of Growing Ordinary Annuity):
n ⟹ FVGA = PMT(1 + r)n−1 + PMT(1 + g)(1 + r)n−2 + ⋯ + PMT(1 + g)𝑛−2 (1 + r)1
n

+ PMT(1 + g)𝑛−1 = ∑ PMT(1 + g)𝑡−1 (1 + r)n−t

t=1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= PMT× [ ]
r−g
• Due (Future Value of Growing Annuity Due):
n ⟹ FVGAD = PMT(1 + r)n + PMT(1 + g)(1 + r)n−1 + ⋯ + PMT(1 + g)𝑛−1 (1 + r)1
n−1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= ∑ PMT(1 + g)𝑡 (1 + r)n−t = PMT× {[ ] ×(1 + 𝑟)}
r−g
t=0
• Solving for Payment
• Present Value
• Ordinary (Present Value of Growing Ordinary Annuity):
n
PMT PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡−1
PMT ⟹ PVGA = + + ⋯ + = ∑
(1 + r)1 (1 + r)2 (1 + r)𝑛 (1 + r)t
t=1
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× [ ]
r−g
 •Due (Present Value of Growing Annuity Due):
n−1
PMT(1 + g) PMT(1 + g)𝑛−1 PMT(1 + g)𝑡
PMT ⟹ PVGAD = PMT + + ⋯ + = ∑
(1 + r)1 (1 + r)𝑛−1 (1 + r)t
t=0
1+𝑔 𝑛
1 − (1 + 𝑟 )
= PMT× {[ ] ×(1 + 𝑟)}
r−g

• Future Value
• Ordinary (Future Value of Growing Ordinary Annuity):
PMT ⟹ FVGA = PMT(1 + r)n−1 + PMT(1 + g)(1 + r)n−2 + ⋯ + PMT(1 + g)𝑛−2 (1 + r)1
n
+ PMT(1 + g)𝑛−1 = ∑ PMT(1 + g)𝑡−1 (1 + r)n−t
t=1
(1 + 𝑟)𝑛 − (1 + g)𝑛
= PMT× [ ]
r−g
• Due (Future Value of Growing Annuity Due):
PMT ⟹ FVGAD = PMT(1 + r)n + PMT(1 + g)(1 + r)n−1 + ⋯ + PMT(1 + g)𝑛−1 (1 + r)1
n−1
𝑡 (1 n−t
(1 + 𝑟)𝑛 − (1 + g)𝑛
= ∑ PMT(1 + g) + r) = PMT× {[ ] ×(1 + 𝑟)}
r−g
t=0
NOTE:
• Future⁡Value = Present⁡Value×(1 + r)n
• Value⁡of⁡Due = Value⁡of⁡Ordinary×(1 + r)
D. INFLATION AND TIME VALUE OF MONEY
• Inflation rate:
Δ𝑃𝑛 𝑃𝑛
𝜋𝑛 = = −1
𝑃𝑛−1 𝑃𝑛−1
𝜋𝑛 = 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛⁡𝑟𝑎𝑡𝑒⁡𝑏𝑒𝑡𝑤𝑒𝑒𝑛⁡𝑝𝑒𝑟𝑖𝑜𝑑𝑠⁡(𝑛 − 1)⁡𝑎𝑛𝑑⁡𝑛
• Adjusting Values for Inflation:
𝑃𝑁
𝑉𝑎𝑙𝑢𝑒⁡𝑖𝑛⁡𝑌𝑒𝑎𝑟⁡𝑁⁡𝐷𝑜𝑙𝑙𝑎𝑟𝑠 = 𝑉𝑎𝑙𝑢𝑒⁡𝑖𝑛⁡𝑌𝑒𝑎𝑟⁡𝑇⁡𝐷𝑜𝑙𝑙𝑎𝑟𝑠×
𝑃𝑇
• Real Cash Flow Versus Nominal Cash Flow
𝑁𝐶𝐹𝑛
𝑅𝐶𝐹𝑛 = ⟺ 𝑁𝐶𝐹𝑛 = 𝑅𝐶𝐹𝑛 ×(1 + 𝜋)𝑛
(1 + 𝜋)𝑛
𝜋 = 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛⁡𝑟𝑎𝑡𝑒⁡𝑝𝑒𝑟⁡𝑝𝑒𝑟𝑖𝑜𝑑
𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟⁡𝑜𝑓⁡𝑝𝑒𝑟𝑖𝑜𝑑𝑠
• Real Interest Rate Versus Nominal Interest Rate
• Fisher Equation:
▪ Exact Equation:
1 + 𝑖 = (1 + 𝑟)×(1 + 𝜋)
⟹ 𝑖 = 𝑟 + 𝜋 + 𝑟×𝜋
1+𝑖
⟹ 1+𝑟 =
1+𝜋
1+𝑖
⟹𝑟= −1
1+𝜋
 ▪ Approximate Equation:
r  i 
𝜋 = 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛⁡𝑟𝑎𝑡𝑒⁡𝑝𝑒𝑟⁡𝑝𝑒𝑟𝑖𝑜𝑑
• Real Future Value Versus Nominal Future Value
• Nominal Future Value:
𝑁𝐹𝑉𝑛
𝑁𝐹𝑉𝑛 = 𝑃𝑉×(1 + 𝑖)𝑛 ⟺ 𝑃𝑉 =
(1 + 𝑖)𝑛
• Real Future Value:
𝑅𝐹𝑉𝑛
𝑅𝐹𝑉𝑛 = 𝑃𝑉×(1 + 𝑟)𝑛 ⟺ 𝑃𝑉 =
(1 + 𝑟)𝑛
• Present Value
𝑁𝐹𝑉𝑛 𝑅𝐹𝑉𝑛 ×(1 + 𝜋)𝑛 𝑅𝐹𝑉𝑛
𝑃𝑉 = 𝑛
= 𝑛 𝑛
=
(1 + 𝑖) (1 + 𝑟) ×(1 + 𝜋) (1 + 𝑟)𝑛
𝑛
𝑅𝐹𝑉𝑛 𝑁𝐹𝑉𝑛 /(1 + 𝜋) 𝑁𝐹𝑉𝑛
𝑃𝑉 = = =
(1 + 𝑟)𝑛 (1 + 𝑖)𝑛 /(1 + 𝜋)𝑛 (1 + 𝑖)𝑛