CHAPTER 2
Mathematics of Finance
In later chapters of this book, we will see how investment decisions made by financial managers, to acquire capital assets such as plant and equipment, and asset managers, to acquire securities such as stocks and bonds, require the valuation of investments and the determination of yields on investments. In addition, when financial managers must decide on alternative sources for financing the company, they must be able to determine the cost of those funds. The concept that must be understood to determine the value of an investment, the yield on an investment, and the cost of funds is the time value of money. This simple mathematical concepts allows financial and asset managers to translate future cash flows to a value in the present, translate a value today into a value at some future point in time, and calculate the yield on an investment. The time-value-of-money mathematics allows an evaluation and comparison of investments and financing arrangements and is the subject of this chapter. We also introduce the basic principles of valuation.
THE IMPORTANCE OF THE TIME VALUE OF MONEY
Financial mathematics are tools used in the valuation and the determination of yields on investments and costs of financing arrangements. In this chapter, we introduce the mathematical process of translating a value today into a value at some future point in time, and then show how this process can be reversed to determine the value today of some future amount. We ...
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