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Understanding Present Value: Implications for Financial Markets and Debt Instruments

This guide explores the concept of present value (PV) as it relates to financial markets and debt instruments. It highlights the importance of cash flows, their timing, and how they impact evaluations and yield to maturity. The guide outlines the fundamentals of present value analysis, illustrating why future cash flows are worth less than current cash due to investment opportunities. Additionally, it introduces key concepts and formulas such as rate, number of periods, payment amount, and future value, essential for understanding investments and loan evaluations.

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Understanding Present Value: Implications for Financial Markets and Debt Instruments

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  1. Bond Math FNCE 4070Financial Markets and Institutions

  2. Present Value Introduction • Different debt instruments have very different streams of cash payments to the holder (known as cash flows), with very different timing. • All else being equal, debt instruments are evaluated against one another based on the amount of each cash flow and the timing of each cash flow. • This evaluation, where the analysis of the amount and timing of a debt instrument’s cash flows lead to its yield to maturity or interest rate, is called present value analysis.

  3. Present Value • The concept of present value (or present discounted value) is based on the commonsense notion that a dollar of cash flow paid to you one year from now is less valuable to you than a dollar paid to you today. This notion is true because you could invest the dollar in a savings account that earns interest and have more than a dollar in one year. • The term present value (PV) can be extended to mean the PV of a single cash flow or the sum of a sequence or group of cash flows.

  4. Rate(nper, pmt, pv, fv, …) • Returns the interest rate per period of an annuity. • Nper – The total number of payment periods • Pmt – The payment made each period (as a negative number) • Pv – the present value of the loan • Fv – the future value or cash balance that you want to have after the last payment is made

  5. PV(rate, nper, pmt, fv, …) • Returns the present value of an investment • Rate – the interest rate per period • Nper – The total number of payment periods • Pmt – The payment made each period (as a negative number) • Pv – the present value of the loan • Fv – the future value or cash balance that you want to have after the last payment is made

  6. PMT(rate,nper,pv,fv,…) • Rate – the interest rate per period • Nper – The total number of payment periods • Pv – the present value of the loan • Fv – the future value or cash balance that you want to have after the last payment is made

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