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Risk-Free Rate
Risk-free rate (interest rate) has a positive relationship with the value of call option. The higher is the interest rate the higher is the Co. This is so because the final payment for the purchase of shares is delayed till the time the option is exercised at some future date. The higher is the R, the lower is the PV of exercise price; since this price is to be subtracted from S, as per Equation

EXAMPLE 2-A.8 (Flat Rate and APR) From the undermentioned facts, develop the repayment schedule for the three consumer financing schemes (A), (B) and (C) using the flat rate of interest. Also, compute the effective rate of interest (APR) Using both long and short-cut approaches.
• Loan amount. Rs 2.40.000
• Repayment period, 3 years
• Rate of interest (flat), 6 per cent
• Repayment pattern: Scheme (A),l

Effective and Flat Rates of Interest
As shown above in the loan repayment/amortization schedule, effective rate of interest (also called annual percentage rate, APR) is applied 10 the diminishing balances of the loan amount to determine the interest content of each installment. When the of interest is applied to the original amount of the loan to determine the interest component, the interest rate is called as f

Example 2-A.6
The lease rentals for as-year contract an: Rs 300/Rs 1,000 payable annually in arrears. Assuming no salvage value, compute the rate of interest implied by the contract and develop a lease amortization schedule.
Solution
The implied rate of interest, i, = Rs 300 x PVIFA ‘(i, 5) = Rs 1.000
PVIFA (i. 5) = 3.333 (The PVIFA closet to 3.333 is 3.52 at 15 per cent)
PVIFA (15. 5) (Table A-4) = 3.352
Th

Loan Repayment Schedule for Annuities
Each installment of an annuity payable PTHLY has two components: (i) the capital (repayment of principal) and (ii) the interest component. To identify these two components. a loan repayment schedule is to be developed. We illustrate below loan repayment schedule with.reference to annuities payable (a) once a year and (b) PTHLY;
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EXAMPLE 2-A.5
The current lease rates quoted by the First Leasing Ltd contracts are: (i) Rs 18 Rs 1.000 month and (ii) Rs 12.5 Rs 1,000, month for speculatively. While the morph circlet, or contract in arrears. The 5 years contract are payable in advance. Assuming 10 percent marginal cost of present values of lease payments.
Solution
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Present Value of an Annuity Payable PTHLY
An annuity payable PTHLY refers to equated/level payment, to he made in intervals less than one year where p denotes the frequency of payment (e.g 12 for monthly payment and 2 for half yearly payment). The present values of an annuity payable PTHLY in (a) affairs, and (b) advance respectively are computed using Equations 2-A-6 and 2-A.7.
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EXAMPLE 2-A.2
The Premier Rank 1 offers to 10 percent interest on a deposit of one year. Assuming (i) annual, (ii) half-yearly and (iii) quarterly frequency of interest compute the effective rates of interests in the three alternatives.
Solution Assuming a deposit of Rs 1.000. the computation of the effective rates of interest is shown below.
We can determine the effective rate given the nominal rate and vice-

Nominal Rates of Interest and Discount
When compounding/discounting has to be done a: intervals less than a year, a distinction should be made between (i) nominal and (iii) effective rates of interest. The coupon rate of interest is ‘called the nominal rate of interest. The nominal rate of interest differs from the effective rate of interest due to the frequency of compounding (e.g. annual, half-yearly, qua

EXAMPLE 2-A.1
Given that PVIF (i, 1) = 0.95 find the value of i and d.
Solution PVIF (i, 1) = 0.95
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