Foundations and Applications of the Time Value of Money

PAMELA PETERSON DRAKE, PHD, CFA, is the J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law at James Madison University. Prior to joining James Madison University, she was an associate dean and professor of finance at Florida Atlantic University, and, previous to that, a professor at Florida State University. FRANK J. FABOZZI, PHD, CFA, CPA, is Professor in the Practice of Finance and Becton Fellow at the Yale School of Management, Editor of the Journal of Portfolio Management, and Associate Editor of the Journal of Structured Finance and the Journal of Fixed Income.

• Preface ixAbout the Authors xiIntroduction xiiiPart One The Basics of the Time Value of Money 1Chapter 1 The Value of Compounding 3Compounding 7Calculator and Spreadsheet Solutions 11Frequency of Compounding 14Summary 20“Try It” Solutions 21Problems 22Chapter 2 Don’t Discount Discounting 23Discounting 23Discounting More Than One Future Value 31Determining the Number of Compounding Periods 35Summary 38“Try It” Solutions 38Problems 39Chapter 3 Cash Happens 41Valuing a Stream of Future Cash Flows 42Valuing a Perpetuity 51Annuities 54Summary 61“Try It” Solutions 62Problems 62Chapter 4 Yielding for Yields 65Annualized Rates of Interest 65Determining the Unknown Interest Rate 77Rules 88Summary 89“Try It” Solutions 90Problems 90Part Two A Few Applications 93Chapter 5 Loans 95Loan Amortization 95Interest Rates on Loans 104Determining the Number of Periods 108Variations on the Theme 109Summary 114“Try It” Solutions 114Problems 115Chapter 6 Saving to Spend 119Valuing a Deferred Annuity 119Annuities with Annuities 126A Bit of Realism 135Summary 138“Try It” Solutions 139Problems 139Chapter 7 Values Tied to Bonds 141Bond Basics 142Calculating the Yield to Maturity 154Issues 157Interest Rates 163Yield Curves 164Summary 169“Try It” Solutions 170Problems 171Chapter 8 Taking Stock 173What’s in a Value? The Basics of Stock Valuation 174Return on Stocks 187Summary 192“Try It” Solutions 193Problems 195Chapter 9 A Capital Idea 197The Net Present Value 198The Profitability Index 201The Internal Rate of Return 204Summary 214“Try It” Solutions 215Problems 216Chapter 10 Finance Fact or Fiction? 219Fact or Fiction: It Pays to Get an MBA 219Fact or Fiction: Leasing a Car Costs Less than Buying a Car 222Fact or Fiction: Gold Has Always Been a Good Investment 225Summary 230Appendix A Using Financial Calculators 231Preparing the Calculator 232The Basics 235Financial Functions 237Tips 242Troubleshooting Problems 243Appendix B Using Spreadsheets in Financial Calculations 247The Basics 247Time Value of Money Functions 248Cash Flow Functions 252Other Useful Functions for Financial Mathematics 253Appendix C Formulas 255Appendix D Glossary 261Appendix E Solutions to End-of-Chapter Problems 265Index 281