Session Plan

 Loan Amortization
 Practice Questions (Time Value of Money)
 Introduction-Fundamentals of Risk & Return
 Definitions-Risk & Return
 Calculation of Expected return

Time Value of Money-III

01. Loan Amortization
If we look at the pattern of the loan payment scheme, we can see that there is always an interest
and principal repayment in each installment. A loan is said to be an amortizing loan if it is repaid
over its term in equal periodic installments.
In the case of leases, mortgages or bank loans, there is a pattern of installment payment. Though
the installment value is fixed throughout the loan term, the interest and principal components are
different. The interest portion should be larger in the initial stage than in the later stages, as the
interest should be computed on the loan outstanding amount.
We will now look at the logic behind the loan amortization;
Assume you obtain Rs. 100,000/= today at an interest rate of 25% per annum, repayable in 4
equal annual installments. Since your annual installments follow a pattern of an annuity, you can
use the annuity factor. But the question is whether it is present or future value of annuity. Again
look at the scenario. There, you should fully repay your loan within 4 years. When you discount
these 4 cash flows you should get Rs. 100,000/= as that should be the today’s value of your
future loan installment payments. We will now apply the present value of annuity formula to find
out the installment.

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Here, the interest portion of the installment is gradually decreasing over the term and the ending
balance of the principal at the 4th year is zero.
Example: You have borrowed a personnel loan of Rs 80,000 from Sampath bank. The loan
requires 8% interest and 4 end of year payments. Prepare a loan amortization schedule.
(15.2 Finance end exam-05 marks)

Practice questions
1) Peris Company (Pvt) Ltd contemplates (consider/think) buying a property three years
from today which will cost them Rs. 1,200,000/=. They wish to set aside a sum of money
today. Money used to finance this purchase will be placed in a savings account paying
interest at a rate of 8% per annum. How much should they save money today?

2) Suppose you have an opportunity to invest in a financial asset that will pay Rs. 250/= at
the end of every year for the next 10 years. You expect a return of 15% compounded
annually. What is the maximum value that you are prepared to pay to obtain the financial
asset today?

3) Niranga invested Rs. 8,000/= savings account at Peoples Bank last year at a
compounding interest rate of 12% per annum. She wishes to withdraw money next year
including the interest accrued and planning to invest the whole withdrawal in Sampath
Bank which gives 12% per annum. If Sampath Bank is going to pay interest quarterly,
what would be the total withdrawal after 5 years from today?

4) Ravi is a marketing manager who has a saving of Rs. 500,000/= today. He had saved Rs.
50,000/= each, every year, for the last 10 years from his job. However he has kept this
money with him rather than investing it. Taniya showed him that he had lost the value of
money due to the opportunity cost involved in retaining that money rather than investing
it. If the annual interest rate was 14%, determine the loss he experience today by holding
the money in liquid form.

5) Sapumal has purchased a property for Rs. 2,000,000. A down payment of Rs. 1,500,000
is paid at the beginning of the mortgage and the balance is to be repaid over 5 years at a
20% per annum interest rate.
a. What will be the periodic payment on this mortgage if the installments are to be
made every semi annum?
b. Determine the future value of total payment to acquire the property at the 5th year.

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 03.Fundamentals of Risk and Return I

01. Introduction
In this chapter we are going to discuss about two key factors in finance, i.e., Risk and Return. It
is well known that greater returns are exposed to greater risks. In the current market there are
different types of investments that the investor can invest in, depending on their risk appetite or
tolerance level. If the same concept is put in other words, investors would willing to take more
risk only that is compensated with high returns –a safe rupee is worth more than a risky rupee! It
implies that the investor will expose himself to a higher risk only if he gets additional rupee
(return) than he would get through a safe investment.

02. Defining Risk

Risk in general is known as the chance of incurring a loss. If any project or asset has a greater
chance of incurring losses, then that project (or asset) is known as a risky venture (or an asset).
Strictly speaking risk is associated with uncertainties.
Uncertainty means the variability of returns related to a given asset. For instance, if you expect
the returns from an asset to vary between 0% - 35%, you would say the asset is risky because
there is a high variability of the asset’s returns.
On the other hand if you invest in government treasury bonds, you are certain (know in advance)
that you would receive the same interest (say 12%) till the maturity of the bond (no variability in
the in the returns). Here, you would term the asset as a risk free asset. More certain the returns
from an asset, the less variability in the returns and therefore less risky asset would be.
Risk can be explained as;
“possibility of the actual returns would be different than the expected returns”; “the uncertainty
that an investment will earn its expected rate of return”.

Defining Return
Return can be understood as the total gain (or loss) experienced by an investor from investing in
an asset in a given period of time.

Rate of Return
When an investor purchases a security he can earn returns in 2 ways. i.e., interest or dividend
income and capital gain or loss. e.g. If you purchased in a share for Rs. 150/= at the beginning of

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2013. By the end of the year the value of the share has appreciated foe Rs. 160/=. Also, during
the period the company paid a dividend of Rs. Rs. 20/= per share. The rate of return of the
security can be calculated as follows;
Rate of Return = Capital Gain + Dividend = Rate of Capital Gain + Rate of interest/ dividend
Initial Share Price
Example 01
You have purchased Hemas PLC shares when stood at Rs.100/= per share 1 year ago. The stock
is currently trading at Rs. 95/= per share. Assume you have just received a Rs. 10/= dividend.
What was the return earned over the past year?

03. Expected Return

Expected return is the amount that an investor would anticipate to receive on an asset that has
various known return. Arithmetically expected return can be expressed as the weighted average
of all the expected possible returns. Here the weights reflect the probabilities of each possible
return.
The returns are not expected to follow the same patters in different scenarios. For instance, when
the country is at booming situation the investment would earn higher returns. In contrast, when
the country is at a recession, the investment would incur a loss or has a return significantly lesser
than in the booming situation. So, the returns will be different based on the economic condition
of the country. But, how to determine what is the future return that the investor would earn on
average in given conditions?
The investor can expect the return by incorporating the theory of probability;

E(R) = ∑ Pi . Ri
𝑖=0

Key: E(R) = the expected return on the stock; n = the number of conditions; Pi = the probability
of condition i; Ri = the return on the stock in state i

“The goal of education is the advancement of knowledge and the dissemination of

truth.”
-John F. Kennedy

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