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Querist : Anonymous

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

amit

amit (Expert)
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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

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.

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CA PARAS BAFNA

CA PARAS BAFNA (Expert)
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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.

amit

amit (Expert)
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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.

Querist : Anonymous

Querist : Anonymous (Querist)

14 November 2010 thank u very much sir and last can we say forward and spot rate one and the same

amit

amit (Expert)
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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