PV = Sum from t=0 till infinity CFt / (1+r)t

CF: cash flow

R: discount rate

100 euros now or in a year?

We should look into interest rate

For an r = 5% , taking 120 euros in a year is more profitable
Because 120 euros discounted backwards, it is 114 now.
However 100 euros will be 105 in a year

Textbook is important: exercise + theory

Course requirements:
Final exam: compulsory: open questions and mcq

Role of the financial manager

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Forward interest rate:

Interest rates are today’s rates for transactions between two future dates
Example: compute the rate from year 3 to year 4

Review exam:
3 Open questions with numbers (2 points each)
MC questions (1 point each) 25

1. Forward interest rates

If I invest a 100 euros today for 2 years, I will get a certain interest rate. The graph
between r and t is flat in the course but in the real world, they actually go up, as an
upward slope. So if you invest for 30 years you get a higher interest rate than if you
invest in year 1.
2 ways of getting to t2
either you invest 2 years at r2
or you invest 1 year at r1 and 1 year at f1,2
they will buy the way that gives you higher return, for example if it’s the first one, this will drive
down the return, higher the price and sell the second way which will increase return and
decrease the price until the two options are equal. This is arbitrage

2. You’re certain that tomorrow, prices for a company will go down (only you have this
info). You don’t have a stock of this company in your portfolio. You make short sale.
Your borrow 1000 stocks but you owe it to the broker, you sell it for 100/stock so you
have +100 000 as cash inflow but at some point you have to return the stocks. After 10
days, price drops to 90 so now what can u do? You can close your short position by
buying stocks for 90, a cash outflow for 90 000. You made a profit of 10 000. Short sale
is the only way you can profit from pessimistic information. It is very present in equity
markets, but not in housing market for example.
What happens if the price goes up? In the short run, people are optimistic and the price
increases to 110. If you close the position now, you have to buy at 110, making an
outflow of 110 000 and thus a loss of 10 000.