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Finance Theory: Present Value Relations

112 minutes of course content

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Course Description

This mini-course from the MIT Open Courseware library, explains the concepts of Present Value Relations within the context of Finance Theory. This forms the basis of the theory of modern financial economics and financial management.

As part of a larger course on Financial Theory, this series of lectures redefines assets as a sequence of current and future cashflows. With this as the basis, students will learn how to derive valuations, calculate net present value, distinguish between two specific types of cashflows, and understand how inflation relates to rates of return.

This course was originally taught in Fall 2008 and references several financial events that occurred at the time.

In this course, you'll learn:

    • Identify assets as a sequence of current and future cash flows
    • Determine valuations of cash flows
    • Calculate net present value of an asset
    • Identify and calculate perpetuities and annuities
    • Apply conventions for compounding
    • Determine the effects of inflation on cashflow valuation
    • Calculate real and nominal rates of return
    1.  Overview and Objectives - 4 minutes

      1. Overview
      2. What do you already know?
    2. Defining Fixed Income Securities - 14 minutes

      1. What is a Fixed Income Security and Industry Overview
      2. Fixed Income Market Participants
    3. Valuation of Coupon Bonds - 22 minutes

      1. Framework for Valuing Fixed Income Securities
      2. Components of Valuation
      3. Pricing Discount Bonds
      4. Discount Bond Prices as an Indicator of Future Interest Rates
      5. Determining Interest Rates of Discount Bonds
      6. Spot Rates of Interest
      7. Defining r
      8. Example: Defining r

    4. Yield Curves - 21 minutes

      1. Term Structure of Interest Rates or the Yield Curve
      2. Yield Curves and Forward Rate Forecasts
      3. Example: Calculating Forward Transactions and Forward Interest Rates
      4. Example: Calculating Forward Interest Rates continued
      5. Example 2: Calculating Forward Interest Rates
    5. Valuation of Coupon Bonds - 9 minutes

      1. What is a Coupon Bond? 
      2. Pricing Coupon Bonds and Bond Yields
    6. Yield Curves and Interest Rates - 4 minutes

      1. What Yield Curves Tell Us About Interest Rates
      2. Changes in Yield Curves and Market Expectations
    7.  Models of the Term Structure - 4 minutes

      1. Different Models of the Term Structure
      2. Expectations Hypothesis 
      3. Do These Models Work? 
    8. Another Valuation Method for Coupon Bonds - 4 minutes

      1. Another Valuation Method for Coupon Bonds
    9. Arbitrage - 8 minutes 

      1. Law of One Price
      2. Arbitrage
      3. Deeper Dive into the Law of One Price
      4. Arbitrage and Short Selling
    10. Multiple Coupon Bond and Fixed-Income Arbitrage - 10 minutes

      1. Multiple Coupon Bonds and Fixed-Income Arbitrage
    11. Measuring Risk - 18 minutes

      1. Overview of Measuring Risk
      2. Macauley Duration as a Measure of Bond Riskiness
      3. Why Macauley Duration Matters
      4. Example: Measuring Interest Rate Risk
      5. Macauley Duration for Intra-year Coupons
      6. Convexity as a Secondary Measure of Risk
      7. Volatility of Interest Rates and Bond Pricing
    12. Corporate Bonds - 12 minutes

      1. Non-Government Bonds and Credit Ratings
      2. Levels of Risk
      3. Example: Moody's Baa Bond Minus US 10-Year Treasury Yield
      4. Decomposition of Corporate Bond Yields
    13. The Subprime Crisis - 25 minutes

      1. Disintermediation and Desecuritization
      2. Combining Risky Bonds into One Portfolio
      3. New Prices of Bonds When Combined into One Portfolio
      4. Why Bonds are Combined
      5. Assuming Perfectly Correlated Defaults
    14. Wrap-up - 2 minutes

      1. What do you know now?

    Andrew Lo. 15.401 Present Value Relations, Fall 2008. (Massachusetts Institute of Technology: MIT OpenCourseWare), (Accessed 29 Jun, 2015). License: Creative Commons BY-NC-SA

                About the Expert

                MIT OpenCourseWare

                MIT OpenCourseWare

                MIT OpenCourseWare (OCW) is a web-based publication of virtually all MIT course content. OCW is open and available to the world and is a permanent MIT activity.
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                Andrew W. Lo

                Andrew W. Lo

                Andrew W. Lo is the Charles E. and Susan T. Harris Professor, a Professor of Finance, and the Director of the Laboratory for Financial Engineering at the MIT Sloan School of Management. Prior to MIT Sloan, he taught at the University of Pennsylvania Wharton School as the W.P. Carey Assistant Professor of Finance from 1984 to 1987, and as the W.P. Carey Associate Professor of Finance from 1987 to 1988.
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