FINANCIAL ARITHMETICS FOR EQUITY

& BONDS

Prof.BALKRISHNA SALUNKHE

Investors make an investment in any asset

(Equity / Debt ) based on following factors:
Credit- worthiness of the party
Time period of lending or investment
Risk of the activity of investment
Expected return over a time period
Safety & marketability of investment

Prof.BALKRISHNA SALUNKHE

Yield on equity
= (dividend + capital gain) / Purchase price
Time value of money
Its based on factors like:
Cost of abstinence from current
consumption
Inflation
Opportunity cost
Prof.BALKRISHNA SALUNKHE

 Future Value of a cash flow:

FV = PV (1+r)n
Where, FV is the future value, PV is the
present value, r is the rate of interest, n is
the number of years.
Future value if compounding is done
number of times during the year

FV = PV [1+ (r/m)] mn
Where, r is nominal interest, m is number of
times compounding is done, n is number of
years.
Prof.BALKRISHNA SALUNKHE

 Annuity is a stream of constant cash flow

(payment or receipt) occurring at regular
intervals of time.
Future Value of an Annuity
= A [(1+r)n -1] /r
Where , A is the amount of annuity per year,
r is the rate of interest, n is the duration of
an annuity. The term [(1+r)n -1] /r is
referred to as the Future value interest
factor for an annuity(FVIFA r,n )
Prof.BALKRISHNA SALUNKHE

Annuity of Rs.1000 each year for 5

years. That means you will invest
1000 each year for 5 years.
Investment is being made at the end
of each year. Assume interest rate of
10% p.a.
What would be accumulated amount
at the end of 5 years?

Prof.BALKRISHNA SALUNKHE

Year
1000

1000

1000

1000

1000
1100
1210
1331
1464

6105

Prof.BALKRISHNA SALUNKHE

 Deposit in PPF Rs.30k p.a. for 30 years.

Assume interest rate of 9%. What would
be accumulated amount?
= 30000 [(1.09)30 -1]/0.09 = 40,89,240

Prof.BALKRISHNA SALUNKHE

 Present Value of a cash flow:

PV = FV / (1+r)n
Where, FV is the future value, PV is the
present value, r is the rate of interest, n is
the number of years.

Prof.BALKRISHNA SALUNKHE

 You expect to receive Rs.1000 p.a.

for next 3 years. The receipt will be
at the end of the year. If the discount
rate is 10%, what is the Present
value of this stream of benefits?

Prof.BALKRISHNA SALUNKHE

10

Present Value of an Annuity

PVA n = A/(1+r) + A/(1+r)2 ++ A/(1+r)n
PVA

= A [1- (1/1+r)n ] /r

Where , A is the amount of annuity per year,

r is the discount rate, n is the duration of
an annuity. The term [1- (1/1+r)n ] /r is
referred to as the Present value interest
factor for an annuity(PVIFA r,n )

Prof.BALKRISHNA SALUNKHE

11

 Suppose u expect to receive Rs.1000 annually

for 3 Years, each receipt is occurring at the end

of year. Whats the present value of this annuity
if discount rate is 10%?
1000(1/1.1)+
1000(1/1.1)2+
1000(1/1.1)3
= 1000(0.909)+1000(0.826)+1000(0.751)=2486

Prof.BALKRISHNA SALUNKHE

12

 Yield to maturity (YTM)

= Interest + (par value-purchase price)/n
(par value + purchase price)/2

Prof.BALKRISHNA SALUNKHE

13

Convertible financing
Delays issue of shares & immediate
dilution of control & earnings
Company gets enough time for
servicing the enhanced capital

Prof.BALKRISHNA SALUNKHE

14

Valuation of Rights:
Right issue is a sale of shares or debentures
to existing shareholders at discounted rate.
Rights Issue: Terms used
Rights Ratio: the number shares entitled on
the basis of shares held on record date
Cum-right price: Price of shares when u r
entitled for getting rights shares, if u buy
shares in stock market
Prof.BALKRISHNA SALUNKHE

15

Ex-right price: price of shares when u r

not entitled for right shares.
Example:
Rights Ratio 2:3, Right Price at Rs.30
Current market price Rs.40 (cum right
price)

Prof.BALKRISHNA SALUNKHE

16

 If u buy 3 shares in market at 40, u r

entitled for 2 right shares at 30.
Total cost of 5 shares
= 3 x 40 + 2 x 30 = 180
Cost per share = Rs.36 per share(180/5)
Ex right price would be Rs.36
Difference of Rs.4 would be value of right.

Prof.BALKRISHNA SALUNKHE

17

Rule of 72:
According to this rule the doubling period is
obtained by dividing 72 by the interest rate.
For e.g. if interest rate is 8%, the doubling
period would be (72 / 8) i.e. 9 years.
Rule of 69:
This is more precise measure of doubling
period
= 0.35 + (69/rate of interest)
E.g. interest rate is 8%
Doubling period would be
=0.35 + (69/8) = 8.975 years.
Prof.BALKRISHNA SALUNKHE

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