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Querist : Anonymous

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Querist : Anonymous (Querist)
14 November 2010 Hi Experts,
In the foward Rate Formulae
(i.e)
present value=Futurevalue(interest)/(1+r1)+Future value(interest+principle)/(1+r1)*(1+r2)
My doubt what is the reason for taking (1+r1) even in the 2nd year?can anyone xplain me



amit
( Expert )
14 November 2010


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this formula will be applicable if the rates in bothe the years are different.

And if the rate is same then you can apply the following formula :

present value=Futurevalue(interest)/(1+r1)+Future value(interest+principle)/(1+r1)*(1+r1)

or

present value=Futurevalue(interest)/(1+r1)+Future value(interest+principle)/(1+r1)^2


So for different rate we have to put (1+r1).



Author : Anonymous
( Author )
14 November 2010
no sir we are discounting future value in the secomg year in such case y we are taking (1+r1) again instead of only (1+r2) pls xplain me in detail im in great confusion

14 November 2010 Let suppose we have a cash flow of INR 10 in year 1 & 2, Int.rate = 10%(yr 1) and 12% (yr2)

Sol: 10/(1.10)^1+10/(1.10)^1*(1.12)^1

for second year the rate is 12% so we will discount the cash flow by 12 % to bring it upto end of 1sr yr and then we will discount it by 10%to bring the figure to the begning of the year 1. If we use (1.10^2) in second year then it denotes that the second year rate is 10% instead of 12%.


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Querist : Anonymous

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Querist : Anonymous (Querist)
14 November 2010 sir if u dnt think trouble can u xplain me what is Forward rate and how it differs with rate of return of(given in the qusetion) and required rate of return with an example pls.



14 November 2010 My answer may not be as relevant to the subject but still it will clarify some of the issues of your quarry-

Present Value-
Suppose if you are supposed to get Rs 10000/- after 3 years from your Anonymous friend.

In spite of waiting you tell him to give Rs 8700/ today. ( Because you know that after 3 yrs this sum will grow in your hands to Rs 10000)

We can say that 8700/- is the Present Value of Rs. 10000/- (at a certain interest rate)

Rate of Return:
This rate through which your sum of Rs.
8700/ has grown to Rs 10000/ in the stipulated period of 3 years is known as Rate of Return.


14 November 2010 Rate of return : Actual return from the investment Ex : A invested 100 INR in W ltd. and after one year he realised 110 then (110-100)/100= 10% is the rate of return

Required rate of return : the return which he expect from his investment based on risk like x want to invest 1000INR in infosys shares and expect to receive 1100 after one year.

so required rate of return is 10%

Forward rate : it is usually used for derivative market. it denotes the rate at which the contract is entered between two parties like A think thar in future the interest rate will increase and current interest rate is 10% then he will find a person who is ready to enter in to the transation @10%. if the rate increased then the difference is his profit or vice versa then loss.

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Querist : Anonymous

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Querist : Anonymous (Querist)
14 November 2010 thank u very much sir and last can we say forward and spot rate one and the same

14 November 2010 Nopes, spot rate is the rate as of today and forward rate (=(spot rate*(1+int rate)^t))is the rate at which contract is entered for future obligation




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