Valuation using forward rates, Financial Management

We can discount cash flows either by using spot rates or forward rates, because a spot rate is simply a package of short-term forward rates. Assume that the cash flow of period T is $1; then, the present value of the cash flow using the spot rate for period T will be as follows:

         PV of $1 in M periods = 1891_valuation using forward rate.png

We know that,

         yT = [(1 + y1) (1 + 1f1) (1 + 1f2) (1 + 1f3) ..... (1 + 1fT-1)]1/ T - 1

Adding 1 on both sides of the equations,

         (1 + yT)  = [(1 + y1) (1 + 1f1) (1 + 1f2) (1 + 1f3) ..... (1 + 1fT - 1)]1/ T

Raising both sides of the equations to the T-th power, we get:

         (1 + yT)T = [(1 + y1) (1 + 1f1) (1 + 1f2) (1 + 1f3) ..... (1 + 1fT - 1)]

The present value of X1 in M periods can be determined by substituting the value calculated in the above step into the present value formula.

         PV of X1 M periods =680_valuation using forward rate1.png

The present value of Rs.1 in T period is called the forward discount factor for period T.

Posted Date: 9/10/2012 2:46:19 AM | Location : United States

Related Discussions:- Valuation using forward rates, Assignment Help, Ask Question on Valuation using forward rates, Get Answer, Expert's Help, Valuation using forward rates Discussions

Write discussion on Valuation using forward rates
Your posts are moderated
Related Questions
1 In the process of considering two job offers, Jill Saunders wants to determine which position would have the higher monetary value. Job 1 has a salary of $42,500 with $4,800 of n

What is triangular arbitrage?  What is a condition that will give increase to a triangular arbitrage opportunity? Answer:  Triangular arbitrage is the method of trading out of th

Discount Rate Determinants The discount rate is the firm weighted average cost of capital. It represents the opportunity cost of investing creditors and shareholders funds in o

Q. Compute the weighted average cost of capital? A company's subsequent to tax specific cost of capital are as follows: Cost of debt

Financial Leverage In accounting and finance, the amount of long lasting debt that an organization has in relation to its equity the longer the ratio, the larger the lever

QUESTION i) Distinguish between intermediated and market finance using illustrative examples. ii) Differentiate between the main characteristics of Debt and Equity. iii)

Question: (a) Show how the Medium Term Expenditure Framework is superior to the traditional one-year presentation of the public sector budget. (b) What are the pre-requisite

Briefly outline the necessities of the UK version of ISA 700/ 750/ 706 and discuss the factors which would manipulate you as the external auditor in forming an opinion on the finan

Question 1 ) A Globalization is a procedure of international integration that arises due to increasing human connectivity as well as the interchange of products, ideas and other ph

Define country risk. How is it different from political risk? Country risk is a broader quantify of risk as compared to the political risk, as the former encompasses political ri