Quantitative finance is built on a foundation of time value of money relationships that allow a single amount of money at one point in time to be converted into an equivalent amount of money at a different point in time given a specified time period and applicable rate.
This rate is typically referred to as an interest rate (when moving forward in time) or discount rate (when moving backward). Sometimes we’re wondering how investments will grow over time. Other times we wonder what future cash flows are worth today or how much we should invest today to meet future obligations.
Judgments about applicable rates are at the heart of current debate about the value of illiquid assets on Wall Street and the negotiations with GM’s bondholders. It all starts with the time value of money formula that unlocks exercises like this.
Exercise:
A zero-coupon bond is a security that pays no interest, and is therefore bought at a substantial discount from its face value. Using a discount rate of 8%, how much would you pay today for a zero coupon bond with a face value of $2,300 that matures in 7 years?
Solution (with audio commentary): click here
Prof. Peter Regan created the self-paced, online MBA Math quantitative skills course and teaches live MBA courses at Dartmouth (Tuck), Duke (Fuqua), and Cornell (Johnson).
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