Deeper Understanding, Faster Calculation--Exam FM Insights & Shortcuts(62页).pdf
Part One: Theories of Interest
Chapter 1
Exam-taking and study strategy............................5
A tale of two Exam FM takers, Mr. Busy and Mr. Lazy..........................................5
Truths about Exam FM...............9
How to study hard yet fail the exam miserably..............................................11
Recommended study method....13
How to build a 3 minute solution script..14
How to eliminate errors............30
Chapter 2 Getting started .............................................................48
Chapter 3 FM Fundamental..........................................................49
Time value of money................49
Principal....................................49
Interest rate................................49
Simple interest rate...................49
Compound interest rate.............50
Force of interest........................52
Nominal interest rate.................58
APR...........................................59
Annual effective interest rate....60
Continuous compounding.........60
Effective annual rate of discount............61
Simple annual rate of discount..63
Nominal annual rate of discount.............63
Future value..............................64
Present value.............................64
Convert interest rate to discount rate or vice versa.........................................66
PV of a stream of cash flows....71
Net Present Value.....................71
Internal rate of return (IRR)......71
Asset and its price.....................73
Convert a cash flow from one point of time to another point of time.....................74
Collapse multiple cash flows into a single cash flow.............................................75
Annuity – collapsing n parallel cash flows into a single cash flow..............................78
Avoid the common pitfall.........79
Perpetuity..................................92
Annuity – payable m-thly in advance.....95
Annuity – payable m-thly in arrears.......97
Increasing annuity...................109
Continuously increasing annuity...........109
Decreasing annuity..................110
Chapter 4 Calculator tips ............................................................125
New features added in BA II Plus Professional...................................................125
How to reset calculators to their best conditions for FM.....................................125
Compound interest..................128
Annuity...................................132
Loan/bond amortization..........141
Compare Cash Flow Worksheet with TVM Worksheet.......................................147
Increasing annuity...................147
Comprehensive calculator exercise.......155
Chapter 5 Geometrically increasing annuity.....................163
Chapter 6 Real vs. nominal interest rate.............................192
Chapter 7 Loan repayment and amortization....................198
Chapter 8 Sinking fund ................................................................224
Chapter 9 Callable and non-callable bonds .........................231
Chapter 10 Valuation of stocks...................................................256
Chapter 11 Price of a bond sold between two coupon
payments 259
Chapter 12 Time weighted return and dollar weighted
return 272
Chapter 13 Investment year & portfolio method ...............287
Chapter 14 Short Sales ...................................................................289
Chapter 15 Term structure of interest rate, spot rate,
forward rate, and arbitrage.............................................................300
Chapter 16 Macaulay duration, modified duration,
convexity 325
Chapter 17 Immunization..............................................................360
Chapter 18 Cash flow matching..................................................378
Value of this PDF study manual......................................................385
About the author...........386
Term structure of interest rate, spot rate, forward rate, and arbitrage
Key points:
1. Law of one price (no arbitrage principle)
Two bonds (or other securities) with identical cash flows should
sell for an identical price.
If they don’t sell for the same price (i.e. if one bond sells at a higher
price than another bond with identical cash flows), anyone can
make money by buying the lower priced bond, turning around, and
selling it at a higher price.
The strategy of exploiting loopholes to make money is called
arbitrage.
Characteristics of arbitrage:
(1) Profit is made with 100% certainty
(2) Profit is made with zero cost
(3) Profit is made with zero risks taken
No arbitrage principle assumes there are no transaction costs such
as tax and commissions.
2. Term structure of interest rates
Term structure of interest refers to the phenomenon that a bond’s
yield-to-maturity changes as the bond’s maturity changes.
A hypothetical example
Maturity of a bond Yield to maturity
1 year 7%
2 year 8%
3 years 8.75%
4 years 9.25%
5 years 9.5%