Lecture 2: Money Flow

Present value of a value A = A(t) at time t in the future is the amount P = A(0) that must be invested now to accumulate A at time t. Total money ow over the period [0, t] is
t

F (t) =
0

f (x)dx

where f (x) is the rate of money ow at time x

Lecture 2: Money Flow

Assume that interest is compounded continuously with a nominal rate r, then the present value of f (x) at time x is f (x)erx and therefore Total Present Value of the money ow over the period [0, t] is
t

P =
0

f (x)erxdx

Accumulated amount at the time t (starting from t = 0) is

t t

A(t) = P e = e

rt

rt 0

f (x)e

rx

dx =
0

f (x)er(tx)dx

Lecture 2: Money Flow

Example Suppose that interest is 5% compounded continuously and the rate of money ow at time x is f (x) = 0.5x. The present value and nal amount of the money ow in 6 years are
6

P =
0

0.5xe0.05xdx

A(6) = P e0.05(6) =

Lecture 2: Money Flow

QUIZ
Assume that interest is 12% compounded continuously, nd the present value and nal amount of a 10 years money ow a) f(x)=300 b) f(x)=0.5x+300 c) 500 e0.02x d) f(x)= 800 e0.05x

Lecture 2: Money Flow

Exercises
1. Frank must make a balloon payment of $20000 in 4 years. Find the present value of the payment if it includes annual interest of 8% 2. The rate of a continuous money ow starts at $1000 and increases exponentially at 5% per year for 4 years. Find the present value and nal amount if interest earned is 11% compounded continuously 3. Find the total nal amount of a continuous money ow in 3 years where the rate is 1000 -x2 and interest is 10% compounded continuously 4. Money is transferred continuously into an account at the constant rate of $1,200 per year. The account earns interest at the annual rate of 8% compounded continuously. How much will be in the account at the end of 2 years?

Lecture 2: Money Flow

5. Jane is trying to decide between two investments. The rst costs $1,000 and is expected to generate a continuous income stream at the rate of f1(t) = 3, 000e0.03t dollars per year. The second investment costs $4,000 and is estimated to generate income at the constant rate of f2(t) = 4, 000 dollars per year. If the prevailing annual interest rate remains xed at 5% compounded continuously over the next 5 years, which investment is better over this time period?
8.3,264,288(5.5,436)

Lecture 2: Money Flow

Homework 1. A constant income stream of M dollars per year is invested at an annual rate r compounded continuously for a term of T years. Find the present value and future value of that investment 2. The winner of a state lottery is oered a choice of either receiving $10 million now as a lump sum or of receiving A dollars a year for the next 6 years as a continuous income stream. If the prevailing annual interest rate is 5% compounded continuously and the two payouts are worth the same, what is A? 3. Adam is trying to choose between two investment opportunities. The rst will cost $50,000 and is expected to produce income at the continuous rate of $15,000 per year. The second will cost $30,000 and is expected to produce income at the rate of $9,000 per year. If the prevailing rate of interest stays constant at 6% per year compounded continuously, which investment is better over the next 5 years?

Lecture 2: Money Flow

4 It is estimated that t weeks from now, contributions in response to a fundraising campaign will be coming in at the rate of f (t) = 6.537e0.3t dollars per week, while campaign expenses are expected to accumulate at the constant rate of $593 per week. For how many weeks does the rate of revenue exceed the rate of cost? and what net earnings will be generated by the campaign during this period?
(5.5)45,39,31,23