Discounting Cash Flow Exercises

Discounting Cash Flow Exercises

Lindsey Matthews

30 years: Risk management & derivatives trading

In this video, Lindsey will run through 4 questions related to the topics he has discussed in the fixed income unlocked series.

In this video, Lindsey will run through 4 questions related to the topics he has discussed in the fixed income unlocked series.

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Discounting Cash Flow Exercises

8 mins 47 secs

Key learning objectives:

  • Identify the formula used to discount future cash flows

  • Applications of the formula

Overview:

This video is a series of questions to test your knowledge on PV calculations.

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Summary

How do we discount future cash flows, at the current yield?

Present value formula outlined below:

PV = CF1/(1+y) + CF2/(1+y)2 + CF3/(1+y)3 + ... + CFn/(1+y)n

What amount would we need to invest today, at the current yield, in order to generate that cashflow at that point in the future?

Question 1: A zero coupon bond pays 100 in 1 year. At a yield of 3% for the year, what is the price today?

Hint: you just need the first term of the formula - PV = CF1/(1+y)

Question 2: A 2 year bond pays a coupon 4, annually, and 100 at maturity. It is trading at a yield of 3%, what is its price?

Hint: use the first two terms of the formula : PV = CF1/(1+y) + CF2/(1+y)2

Question 3: Estimate what you think a 4 year bond, paying a 4% coupon, priced at 3% yield is worth.

Hint: 1 every year for 4 years, discounted.

Use the following formula: PV = CF1/(1+y) + CF2/(1+y)2 + CF3/(1+y)3 + CF4/(1+y)4

Question 4: A bond pays a coupon of 4% semi-annually - assume 2 every half year. And it is priced at a yield of 3% - or 1.5% for every half year. What is the value of the bond discounted at this yield?

Hint:
Year Cashflow Discount Factor PV
0.5
1
1.5
2
2.5
3
3.5
4
 

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Lindsey Matthews

Lindsey Matthews

Lindsey runs Perfordiant, an investment risk and performance consulting firm. He has worked in financial markets since 1992. Lindsey became an MD in fixed income and equities, ran a Risk function, and was on the management team of an Asset Management fintech business. Lindsey is now a Visiting Fellow at the Henley Business School, and resides on the board of CFA UK.

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