Applications of Simple Interest Valuation Principle参考.ppt

Chapter 7 Applications of Simple Interest 7.2 Valuation Principle For investments purchased privately, you have some flexibility to negotiate a higher rate of return by bargaining down the price. But for various types of investments available to the general public, the rates of return are determined by market forces of supply and demand. When an investment’s price is established by competitive bidding among many buyers and sellers, we refer to the price as the fair market value. A particular fair market value implies a specific value for the rate of return used to discount the future cash flows from the investment. This rate of return is what we mean by the market-determined rate of return. These ideas are so important and of such wide application in finance that they are formally embodied in Valuation Principle. Valuation Principle The Valuation Principle is an extension of the concept of the equivalent value of a payment stream. The sum of present values of the expected cash flows represents their combined equivalent value on the investment date. The time value of money in this context is the market-based required rate of return. Example 7.2 A Valuation of a Non-Interest-Bearing Obligation An investment contract calls for a payment of $1000 five months from now and another payment, 10 months from now, of $1500. a,What price will an investor be prepared to pay for the investment today if the required rate of return is 12% pa? b,Demonstrate that the investor will realize a 12% rate of return on the purchase price if the payments are received as expected. a P1 represents the present value of $1000 in 5 months r1=12% t1=5/12 years s1=$1000 P2 represents the present value of $1500 in 10 months An investor requiring a 12% rate of return should be willing to pay $2316.02 today for the contract. b Demonstrate that the investor will realize a 12% rate of return on $952.38 an