Gordon Guides - Exam Success CFA Exam Prep

1 Gordon Guides For the llqp Exam Financial Math For the llqp Exam, candidates are expected to have a high degree of understanding of time value of money principles, security valuation and basic statistics. Formulas are provided on the exam, therefore do not memorize them only know how to use them! Candidates report that a lot of relatively easy marks are often missed because of a lack of familiarity with basic Math skills and most surprising simply not knowing how to use a financial calculator correctly.

2 If you are weak in Math and have never used a financial calculator, we suggest you use the Texas Instruments BA II not buy the HP 10B or will spend weeks just learning how to turn it on! The BA II PLUS is a much simpler machine to operate, it can do all of the required calculations and it costs about one half the price of the HPs. Exam Success Inc. Tel: (416) 318-4357 1 Email: Gordon Guides For the llqp Exam Present Value of an Annuity The present value of an annuity tells us how much money we need to have today in order to fund a specific dollar amount of income over a specific period of time paid at a specific time interval.

3 If that sounds like a mouthful, let`s look at an example to clarify exactly what we are talking about. Consider the following example: Assume that Jarrod would like to be able to withdraw $1,000 per year for the next 3 years from his TFSA. If the local bank pays interest on savings held in a TFSA of and Jarred makes his withdrawals at the end of the year, how much will Jarred need to have in his account today? The answer is $2, Time Lines Time lines can help visualize the amounts and the timing of the cash flows.

4 In Jarred s case the time line would look like this, cash flows occur at the end of the time period: -$2, $1,000 $1,000 $1,000 Today End of End of End of the first the second the third year year year Exam Success Inc. Tel: (416) 318-4357 2 Email: Gordon Guides For the llqp Exam We can use the following formula to solve for the present value of an annuity : PVA = PMT x 1 - (1 + i)-n i Where: PVA = Future Value of the Annuity PMT = Annuity amount i = stated annual interest rate n = number of time periods In Jarred s case we can calculate exactly how much he needs to have in order to withdraw $1,000 per year for the next 3 years, in just one step by using the formula.

5 PVA = PMT x 1 - (1 + i)-n i = $1,000 x 1 - (1 + )-3 = $2, We could also use the time value of money buttons on a financial calculator to calculate this as well: END MODE FV = $0 Remember the future value of an annuity is ALWAYS 0! i = Enter the interest rate as a whole number, do not hit % or make it a decimal n = 3 Enter the number of time periods PMT = $1,000 Payments refers to the amount of income paid out each time period. Solve for PV = $2, You get a negative number indicating an outflow or deposit Exam Success Inc.

6 Tel: (416) 318-4357 3 Email: Gordon Guides For the llqp Exam Timing of the Cash Flows You should be aware of the END MODE and BEG MODE functions on your calculator and how they affect your calculation. Recall the time line above, the cash flows occur at the end of the time period. What do you think would happen if the cash flows occurred at the beginning of the time period? BGN MODE FV = $0 Remember the future value of an annuity is ALWAYS 0! i = Enter the interest rate as a whole number, do not hit % or make it a decimal n = 3 Enter the number of time periods PMT = $1,000 Payments refers to the amount of income paid out each time period.

7 Solve for PV = $2, You get a negative number indicating an outflow or deposit With the payments at the beginning of the time period you get a different answer! Exam Success Inc. Tel: (416) 318-4357 4 Email: Gordon Guides For the llqp Exam Quick Summary Time Value of Money Concepts A. Types and measures of investment returns Time Value of Money Lump-Sum Formulas on the left and the corresponding calculator key strokes on the right, followed by an example. Present value of a lump sum payment Enter the following information given in the question: PV = FV FV n I PMT solve for: PV ( 1 + I )n Example: You require $10,000 in 5 years to payoff your car loan.

8 If your savings can grow annually at 8% (ignoring taxes), how much must you deposit in your savings account today? PV = $10,000 Enter -$10,000 FV , 5 n , 8 I , 0 PMT ( )5 Solve for PV = $6, = $6, Future value of a lump sum payment Enter the following information given in the question: FV = PV( 1 + I )n PV n I PMT solve for: FV Example: If your savings can grow annually at 11% (ignoring taxes), how much will $3,500 grow to in 15 years?

9 FV = $3,500 ( )15 Enter -$3,500 PV , 15 n ,11 I , 0 PMT Solve for FV = $16, = $16, Exam Success Inc. Tel: (416) 318-4357 5 Email: Gordon Guides For the llqp Exam Examples: Your client stated that she will need $10,000 in 4 years to pay for her daughter s wedding. Your client would like to know the minimum amount of money she would need to invest in a time deposit in order to achieve her goal? Assume the current rate on 4 year time deposits is 4%.

10 The answer is $8, Your client has $5,250 in cash in an RRSP account. What will the account balance be at the end of 10 years if you were to invest the entire amount is a Government of Canada Strip Bond that is yielding 6% per annum. The answer is $9, Exam Tip: Make sure you are comfortable with your financial calculator. Many exam candidates make mistakes because they do not know how to use their calculator correctly! Simple time value of money questions do show up on the Exam and are easy points!