Question 4

a. Differentiate between the concepts of discounting and compounding as they relate to cash flow valuations. ( 1 mark)

b. What are the differences among a lump sum, annuity, perpetuity and a growing annuity? Show by way of formulae and example, how the present values and future values of each of the different cash flows listed above can be computed. (4 marks)

c. Illustrate which formulas or a combination of formulas can be used to determine the following: (1) amount loan to be amortized over a period of time, given a loan amount and applicable interest rate, (2) bonds valuation and stock valuation. (4 marks)

d. Show by way examples which approach(es) can be used to calculate the yield to maturity of a bond. (2 marks)

e. What are theoretical differences between how bonds are valued and how stocks are valued? (2 marks)

f. What is the difference between the effective annual rate and the annual percentage rate? When do we compute each? (2 marks)