2 - Financial markets arithmetic

Abstract

This chapter introduces the basic building blocks of corporate finance. These include the principles of compounded interest, the time value of money, and future and present values. The notion that money has a time value is a basic concept in the analysis of financial instruments. Money has time value because of the opportunity to invest it at a rate of interest. The interest rate quoted on a deposit or loan is usually the flat rate. However, investors are often required to compare two interest rates that apply for a similar investment period but have different interest payment frequencies. This is done by comparing equivalent annualized rates. Two common techniques used by companies and governments to evaluate whether a project is worth undertaking are net present value and internal rate of return. In project appraisal, there is a need to find the present value of the entire stream of cash flows, and the sum of all positive and negative present values added together is the net present value (NPV).