Quantifying Time Value Errors
DOI:
https://doi.org/10.1016/1057-0810(95)90015-2Abstract
Time valuation of cash flows is an essential part of personal financial planning and management. Many financial arrangements are priced according to a cash-jlow valu- ation model. Expected cash flows associated with a stock or bond are discounted at an appropriate risk-adjusted rate in order to determine the fair value of the financial asset. Home mortgage loans arepriced according to the discounted value of thefitureprincipal and interest cash flows. Yet, despite the importance of the discounted cashflow method- ology in pricing assets, computational errors are often made when discount factors are not calculatedprecisely. This article attempts to quantify the magnitude of the error when the mathematicalfirnction for present value is ignored and interpolation is used instead to determine the discount factor,
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