●Future value- Amount to which an investment will grow after earning interest.

For an interest rate of r and a horizon of t

Future value of $100 = $100 * (1 + r)^t

●Earning interest on interest is called compounding or compound interest. In contrast, if the bank calculated the interest only
on your original investment, you would be paid simple interest

●We have seen that $100 invested for 1 year at 6 percent will grow to a future value of 100 × 1.06 = $106. Let’s turn this
around: How much do we need to invest now in order to produce $106 at the end of the year? Financial managers refer to this
as the present value (PV) of the $106 payoff.

Present value = future value after t periods/(1+r)^t r-interest

`DISCOUNT FACTOR-Present value of a $1 future payment. 1/(1+r)^t

`Multiple cash flows- So far, we have considered problems involving only a single cash flow. This is obviously limiting. Most
real-world investments, after all, will involve many cash flows over time. When there are many payments, you’ll hear
businesspeople refer to a stream of cash flows.

Future value of a stream of cash flows

Present value of a stream of cash flows

`A 4-year car loan might require 48 equal monthly payments. Any such sequence of equally spaced, level cash flows is called an
annuity. If the payment stream lasts forever, it is called a perpetuity.
Present value of perpetuity

Present value of t-year annuity

`A level stream of payments starting immediately is known as an annuity due.

PV annuity due = 1 + PV ordinary annuity of t – 1 payments=

`future value of annuity of $1 a year

`l general rise in prices is known as inflation. Economists track the general level of prices using several different price indexes.
The best known of these is the consumer price index, or CPI. This measures the number of dollars that it takes to buy a
specified basket of goods and services that is supposed to represent the typical family’s purchases. Thus the percentage
increase in the CPI from one year to the next measures the rate of inflation.

`REAL VALUE OF $1 Purchasing power-adjusted value of a dollar

`NOMINAL INTEREST RATE Rate at which money invested grows.

REAL INTEREST RATE Rate at which the purchasing power of an investment increases

Real interest rate ≈ nominal interest rate – inflation rate

`EFFECTIVE ANNUAL INTEREST RATE Interest rate that is annualized using compound interest.

EX; if you borrow $100 from the credit card company at 1 percent per month for 12 months, you will need to repay $100 ×
(1.01)^12 = $112.68. Thus your debt grows after 1 year to $112.68. Therefore, we can say that the interest rate of 1 percent a
month is equivalent to an effective annual interest rate, or annually compounded rate of 12.68 percent.

`ANNUAL PERCENTAGE RATE (APR) Interest rate that is annualized using simple interest
Ex: The interest rate on your credit card loan was 1 percent per month. Since there are 12 months in a year, the APR on the loan
is 12 × 1% = 12%.

`SOLE PROPRIETOR Sole owner of a business which has no partners and no shareholders. The proprietor is personally liable for
all the firm’s obligations.

PARTNERSHIP Business owned by two or more persons who are personally responsible for all its liabilities.

CORPORATION Business owned by stockholders who are not personally liable for the business’s liabilities.

LIMITED LIABILITY The owners of the corporation are not personally responsible for its obligations.

`REAL ASSETS Assets used to produce goods and services

`FINANCIAL ASSETS Claims to the income generated by real assets. Also called securities

`Flow of cash between capital markets and the firm’s operations

`CAPITAL BUDGETING DECISION Decision as to which real assets the firm should acquire.

`FINANCING DECISION Decision as to how to raise the money to pay for investments in real assets

When a company needs financing, it can invite investors to put up cash in return for a share of profits or it can promise
investors a series of fixed payments. In the first case, the investor receives newly issued shares of stock and becomes a
shareholder, a part-owner of the firm. In the second, the investor becomes a lender who must one day be repaid. The choice of
the longterm financing mix is often called the capital structure decision, since capital refers to the firm’s sources of long-term
financing, and the markets for long-term financing are called capital markets.

`FINANCIAL INTERMEDIARY Firm that raises money from many small investors and provides financing to businesses or other
organizations by investing in their securities. Ex; banks, insurance company

`FINANCIAL MARKETS Markets in which financial assets are traded.

`A new issue of securities increases both the amount of cash held by the company and the amount of stocks or bonds held by
the public. Such an issue is known as a primary issue and it is sold in the primary market
`SECONDARY MARKET Market in which already issued securities are traded among investors.

Ex; Smith might decide to raise some cash by selling her AT&T stock at the same time that Jones invests his spare cash in AT&T.
The result is simply a transfer of ownership from Smith to Jones,

`TREASURER Manager responsible for financing, cash management, and relationships with financial markets and institutions.

`CONTROLLER Officer responsible for budgeting, accounting, and auditing.

`CHIEF FINANCIAL OFFICER (CFO) Officer who oversees the treasurer and controller and sets overall financial strategy

`AGENCY PROBLEMS Conflict of interest between the firm’s owners and managers

`STAKEHOLDER Anyone with a financial interest in the firm.

`Financial planning is a process consisting of: 1. Analyzing the investment and financing choices open to the firm. 2. Projecting
the future consequences of current decisions. 3. Deciding which alternatives to undertake. 4. Measuring subsequent
performance against the goals set forth in the financial plan

`PLANNING HORIZON Time horizon for a financial plan. (a typical planning horizon is 5 years)

`Financial plans include three components: inputs, the planning model, and outputs.

1 Inputs. The inputs to the financial plan consist of the firm’s current financial statements and its forecasts about the future.

2 The Planning Model. The financial planning model calculates the implications of the manager’s forecasts for profits, new
investment, and financing. The model consists of equations relating output variables to forecasts

3 Outputs. The output of the financial model consists of financial statements such as income statements, balance sheets, and
statements describing sources and uses of cash

`PRO FORMAS Projected or forecasted financial statements.

`PERCENTAGE OF SALES MODELS Planning model in which sales forecasts are the driving variables and most other variables are
proportional to sales.

`BALANCING ITEM Variable that adjusts to maintain the consistency of a financial plan. Also called plug

`INTERNAL GROWTH RATE Maximum rate of growth without external financing.

A forward contract is an arrangement that is made over-the-counter (OTC) and settles just once at the end of the contract.
Both parties involved in the agreement negotiate the exact terms of the contract. It is privately negotiated and comes with a
degree of default risk since the counterparty is responsible for remitting payment.

Ex; Let's assume that a producer has an abundant supply of soybeans and is concerned that the price of the commodity will
drop in the near future. In order to hedge the risk, the producer negotiates a contract with a financial institution that involves
the sale of three million bushels of soybeans at a price of $6.50 per bushel in six months. Both parties agree to settle the
contract in cash.

Soybean prices have a few ways to move by the time the contract is ready for settlement:

1.The price is exactly as contracted. The contract is settled as per the agreement and neither party owes the other any
additional money.

2.The price is lower than the negotiated price. Let's say the price drops to $5 per bushel, the settlement still goes through at the
agreed-upon price. This means the producer's bet to hedge the risk of a price drop works.

3. The price is higher than the agreed-upon price. The contract is settled at the negotiated price, even though the producer may
have profited from a higher price per barrel.

Main Disadvantages of a Forward Contract?

There are several key disadvantages of a forward contract. For instance, their details are not made public as they are
negotiated privately between the two parties involved and because they trade over-the-counter. As such, these derivatives
aren't regulated and come with a greater degree of risk. Settlement isn't guaranteed until the contract's maturity date.

Futures contracts, on the other hand, are standardized contracts that trade on stock exchanges. As such, they are settled on a
daily basis. These arrangements come with fixed maturity dates and uniform terms. There is very little risk with futures, as they
guarantee payment on the agreed-upon date.

Ex:. Oil producers often use futures contracts to sell the commodity. This allows them to lock in a price to sell it and complete
delivery once the expiration date hits.

Differences of forward and futures

One of the things that set forward contracts from futures contracts is how they're regulated. Forward contracts aren't regulated
at all while futures are overseen by a central government body. The agency that provides oversight and regulation of futures
contracts is the Commodity Futures Trading Commission (CFTC).

Guarantees for each contract are also provided by different parties. Since forwards are privately negotiated, they provide the
guarantee to settle the contract. Futures, on the other hand, have an institutional guarantee provided by the clearinghouses
that back them.

What Advantages Do Futures Contracts Have Over Forward Contracts?

Details of futures contracts are made public because they are traded on exchanges, unlike forwards, which are negotiated
privately between counterparties. Because futures are regulated, they come with less counterparty risk that forward contracts.
These contracts are also standardized, which means, they come with a set terms and expiry date. Forwards, on the other hand,
are customized to the needs of the parties involved.

`Option- The term option refers to a financial instrument that is based on the value of underlying
securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending
on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy
or sell the asset if they decide against it. Each contract will have a specific expiration date by which the
holder must exercise their option. The stated price on an option is known as the strike price. Options are
typically bought and sold through online or retail brokers.

Options are versatile financial products. These contracts involve a buyer and seller, where the buyer
pays a premium for the rights granted by the contract. Call options allow the holder to buy the asset at a
stated price within a specific timeframe. Put options, on the other hand, allow the holder to sell the
asset at a stated price within a specific timeframe. Each call option has a bullish buyer and a bearish
seller while put options have a bearish buyer and a bullish seller.

American options can be exercised any time before the expiration date of the option, while European
options can only be exercised on the expiration date or the exercise date. Exercising means utilizing the
right to buy or sell the underlying security.

Options Risk Metrics: The Greeks

The options market uses the term Greeks to describe the different dimensions of risk involved in taking
an options position, either in a particular option or a portfolio.

Delta (Δ) represents the rate of change between the option's price and a $1 change in the underlying
asset's price. In other words, the price sensitivity of the option relative to the underlying. Delta of a call
option has a range between zero and one, while the delta of a put option has a range between zero and
negative one.

Theta (Θ) represents the rate of change between the option price and time, or time sensitivity -
sometimes known as an option's time decay. Theta indicates the amount an option's price would
decrease as the time to expiration decreases, all else equal.

Gamma (Γ) represents the rate of change between an option's delta and the underlying asset's price.
This is called second-order (second-derivative) price sensitivity. Gamma indicates the amount the delta
would change given a $1 move in the underlying security.

Vega (V) represents the rate of change between an option's value and the underlying asset's implied
volatility. This is the option's sensitivity to volatility. Vega indicates the amount an option's price changes
given a 1% change in implied volatility.

Rho (p) represents the rate of change between an option's value and a 1% change in the interest rate.
This measures sensitivity to the interest rate.

ADVANTAGES AND DISADVANTAGES

A call option buyer has the right to buy assets at a lower price than the market when the stock's price rises

The put option buyer profits by selling stock at the strike price when the market price is below the strike price

Option sellers receive a premium fee from the buyer for writing an option

Cons

The put option seller may have to buy the asset at the higher strike price than they would normally pay if the market falls

The call option writer faces infinite risk if the stock's price rises and are forced to buy shares at a high price
Option buyers must pay an upfront premium to the writers of the option

Example of an Option

Suppose that Microsoft (MFST) shares trade at $108 per share and you believe they will increase in value. You decide to buy a
call option to benefit from an increase in the stock's price. You purchase one call option with a strike price of $115 for one
month in the future for 37 cents per contact. Your total cash outlay is $37 for the position plus fees and commissions (0.37 x
100 = $37).

If the stock rises to $116, your option will be worth $1, since you could exercise the option to acquire the stock for $115 per
share and immediately resell it for $116 per share. The profit on the option position would be 170.3% since you paid 37 cents
and earned $1—that's much higher than the 7.4% increase in the underlying stock price from $108 to $116 at the time of
expiry.

In other words, the profit in dollar terms would be a net of 63 cents or $63 since one option contract represents 100 shares [($1
- 0.37) x 100 = $63].

If the stock fell to $100, your option would expire worthlessly, and you would be out $37 premium. The upside is that you didn't
buy 100 shares at $108, which would have resulted in an $8 per share, or $800, total loss. As you can see, options can help limit
your downside risk.

What Are the Main Advantages of Options?

Options can be very useful as a source of leverage and risk hedging. For example, a bullish investor who wishes to invest $1,000
in a company could potentially earn a far greater return by purchasing $1,000 worth of call options on that firm, as compared to
buying $1,000 of that company’s shares.

In this sense, the call options provide the investor with a way to leverage their position by increasing their buying power.

On the other hand, if that same investor already has exposure to that same company and wants to reduce that exposure, they
could hedge their risk by selling put options against that company.

What Are the Main Disadvantages of Options?

The main disadvantage of options contracts is that they are complex and difficult to price. This is why are considered an
advanced investment vehicle, suitable only for experienced professional investors. In recent years, they have become
increasingly popular among retail investors. Because of their capacity for outsized returns or losses, investors should make sure
they fully understand the potential implications before entering in to any options positions. Failing to do so can lead to
devastating losses.

`A swap is a derivative contract through which two parties exchange the cash flows or liabilities from two different financial
instruments. Most swaps involve cash flows based on a notional principal amount such as a loan or bond, although the
instrument can be almost anything. Usually, the principal does not change hands. Each cash flow comprises one leg of the
swap. One cash flow is generally fixed, while the other is variable and based on a benchmark interest rate, floating currency
exchange rate, or index price.

An interest rate swap is a forward contract in which one stream of future interest payments is exchanged for another based on
a specified principal amount. Interest rate swaps usually involve the exchange of a fixed interest rate for a floating rate, or vice
versa, to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would
have been possible without the swap.

Swap risk Like most non-government fixed income investments, interest-rate swaps involve two primary risks: interest rate risk
and credit risk, which is known in the swaps market as counterparty risk.

`What Is a Bond? A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically
corporate or governmental). Bonds are used by companies, municipalities, states, and sovereign governments to finance
projects and operations. Owners of bonds are debtholders, or creditors, of the issuer.
Characteristics of Bonds

Most bonds share some common basic characteristics including:

Face value is the money amount the bond will be worth at maturity; it is also the reference amount the bond issuer uses when
calculating interest payments. For example, say an investor purchases a bond at a premium of $1,090, and another investor
buys the same bond later when it is trading at a discount for $980. When the bond matures, both investors will receive the
$1,000 face value of the bond.

The coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.1 For
example, a 5% coupon rate means that bondholders will receive 5% x $1000 face value = $50 every year.

Coupon dates are the dates on which the bond issuer will make interest payments. Payments can be made in any interval, but
the standard is semiannual payments.

The maturity date is the date on which the bond will mature and the bond issuer will pay the bondholder the face value of the
bond.

The issue price is the price at which the bond issuer originally sells the bonds.

`Two features of a bond—credit quality and time to maturity—are the principal determinants of a bond's coupon rate. If the
issuer has a poor credit rating, the risk of default is greater, and these bonds pay more interest. Bonds that have a very long
maturity date also usually pay a higher interest rate. This higher compensation is because the bondholder is more exposed to
interest rate and inflation risks for an extended period.

`There are four primary categories of bonds sold in the markets. However, you may also see foreign bonds issued by
corporations and governments on some platforms.

Corporate bonds are issued by companies. Companies issue bonds rather than seek bank loans for debt financing in many cases
because bond markets offer more favorable terms and lower interest rates.

Municipal bonds are issued by states and municipalities. Some municipal bonds offer tax-free coupon income for investors.

Government bonds such as those issued by the U.S. Treasury. Bonds issued by the Treasury with a year or less to maturity are
called “Bills”; bonds issued with 1–10 years to maturity are called “notes”; and bonds issued with more than 10 years to
maturity are called “bonds.” The entire category of bonds issued by a government treasury is often collectively referred to as
"treasuries." Government bonds issued by national governments may be referred to as sovereign debt.

Agency bonds are those issued by government-affiliated organizations such as Fannie Mae or Freddie Mac.

Varieties of Bonds

The bonds available for investors come in many different varieties. They can be separated by the rate or type of interest or
coupon payment, by being recalled by the issuer, or because they have other attributes.

Zero-Coupon Bonds

Zero-coupon bonds do not pay coupon payments and instead are issued at a discount to their par value that will generate a
return once the bondholder is paid the full face value when the bond matures. U.S. Treasury bills are a zero-coupon bond.4

Convertible Bonds

Convertible bonds are debt instruments with an embedded option that allows bondholders to convert their debt into stock
(equity) at some point, depending on certain conditions like the share price5. For example, imagine a company that needs to
borrow $1 million to fund a new project. They could borrow by issuing bonds with a 12% coupon that matures in 10 years.
However, if they knew that there were some investors willing to buy bonds with an 8% coupon that allowed them to convert
the bond into stock if the stock’s price rose above a certain value, they might prefer to issue those.
`YTM is a complex calculation but is quite useful as a concept evaluating the attractiveness of one bond relative to other bonds
of different coupons and maturity in the market. The formula for YTM involves solving for the interest rate in the following
equation, which is no easy task, and therefore most bond investors interested in YTM will use a computer:

`The biggest difference between premium and discount bonds centers on their trading price, relative to their par value.
Premium bonds trade above par value while discount bonds trade below it.

`These are the risks of holding bonds:

Risk #1: When interest rates fall, bond prices rise.

Risk #2: Having to reinvest proceeds at a lower rate than what the funds were previously earning.

Risk #3: When inflation increases dramatically, bonds can have a negative rate of return.

Risk #4: Corporate bonds depend on the issuer's ability to repay the debt, so there is always the possibility of default of
payment.

Risk #5: A low corporate credit rating may cause higher interest rates on loans and therefore impact bondholders.

Risk #6: Low liquidity in some bonds can cause price volatili