Finance Essentials: A Guide to Key Concepts and Formulas

Mathematics24 Jun 20245.23 KB

Finance Essentials

Future Value: Amount to which an investment will grow after earning interest
Present Value: Value today of a future cash flow

Compound Interest: Interest earned on interest
Simple Interest: Interest earned only on the original investment
Annual Percentage Rate (APR): Interest rate that is annualized using simple interest
Effective Annual Rate (EAR): Interest rate that is annualized using compound interest

Annuity: Equally spaced level stream of cash flows for a limited period of time
- Ordinary Annuity: End of period cash flows
- Annuity Due: Beginning of period cash flows
Perpetuity: A stream of level cash payments that never ends

Bond: Security that obligates the issuer to make specified payments (periodic interest payments and returns of principal) to the bondholder
Coupon: The interest payments made to the bondholder
Coupon Rate: Annual interest payment, as a percentage of face value
Face Value: Payment at the maturity of the bond
Bond Pricing: The price of a bond is the present value of all cash flows generated by the bond discounted at the required rate of return
Interest Rate Risk: As interest rates increase, present values decrease (Vice Versa)
Yield to Maturity (YTM): Approximate rate of return assumes that one will hold the bond until maturity, interest rate for present value of bond cash flows equals the bond price. Yield to maturity, required return, and market rate are used interchangeably.
Bond Ratings:
- AAA: Strongest
- AA: Strong
- A: Strong but some vulnerability
- Baa (BBB): Adequate
- Ba (BB): Considerable uncertainty
- B: Questionable to be repaid
- Caa (CCC) / Ca (CC): May already be in default
- C: Offer little prospect for principal/interest to be paid
- Ba (BB) or lower: Considered junk bonds
Corporate Bonds/Default Risk: Market yield to maturity on bonds, other than U.S. Treasury bonds, include default or credit risk premium
Default Risk Premium: The difference between the yield on a risky bond and a U.S. Treasury bond of similar maturity

Share of Stock: Gets paid via dividends or from selling the share
Dividend Discount Model (DDM): P₀ = D₁ - P₁ / 1 + r
DDM with no Growth: P₀ = Div / R
Constant Growth DDM: P₀ = D₀(1 + G) / r - g = D₁ / r - g
Expected Rate of Return:
- P₀ = D₀(1 + G) / r - g = D₁ / r - g
- OR
- R = (D₀(1 + G) / P₀) + G = (D₁ / P₀) + G

Present Value: =PV(FV, Nper(Number of Yrs), Rate (Interest))
Interest Rate: =RATE(Nper (years), -PV, FV)
Number of Periods: =NPER(Rate, -PV, FV)
Future Value: =FV(Rate (divided by 12 for monthly, 4 for quarterly, 2 for semi-annual), Nper (multiplied by 12, 4, 2), -PV)

Present Value (Cash Flow): =NPV(Rate, value 1(table with values)
Present Value for Annuity: =PV(Rate, NPER, -PMT)
Annuity Payments: =PMT(Rate (Divided by 12 for monthly, 4 quarterly, etc.), NPER (multiplied by 12, 4, 2), PV)
Future Value for Annuity: =FV(Rate / 12, 4, 2), Nper (x 12, 4, 2), -Pmt)
Number of Payments: =NPER(rate, -pmt, PV)
PV of Ordinary Annuity: =PV(Rate, Nper, -pmt)
PV of Annuity Due: =PV(rate, NPER, -pmt)

EAR: =EFFECT(Nominal_Rate(APR), Npery(Compounding)
APR: =NOMINAL(Effect Rate(EAR), Npery(compounding)
Yield to Maturity: =YIELD(Settlement, Maturity, Coupon Rate, PR (Bond Price), Redemption (Face Val), Frequency (Coup per year)
Annual Coupons: =PRICE(Settlement, Maturity, Rate, Yield, Redemption (Face Val), Frequency (Coup)
Dollar Price of Bond: =Bond Price x 10