Cashflow model
A mathematical projection of the payments arising from a financial transaction, eg a loan, a share or a capital project
Payments received = income
Payments made = outgo
Net cashflow = income - outgo
Zero-coupon bond
A security that is simply a contract to provide a specified lump sum at some specified future date
For the investor there is a negative cashflow at the point of investment and a single known positive cashflow on the specified future date
Fixed-interest security
A loan which is issued in bonds of a stated nominal amount
The holder of such a bond will receive a lump sum of a specified amount at some specified future time together with a series of regular level interest payments until the repayment/redemption of the lump sum
The investor has an initial negative cashflow, a single known positive cashflow on the specified future date, and a series of smaller known positive cashflows on a regular set of specified future dates
Inflation
Measure of the rate of change of the price of goods and services, including salaries
Inflation-linked security
A security for which the actual cash amount of future interest payments and the final capital repayment are linked to an index which reflects the effects of inflation
The initial negative cashflow is followed by a series of unknown positive cashflows and a singular larger unknown positive cashflow, all on specified dates
Since they future cashflows relate to the inflation index it can be said that these cashflows are known in real terms
Cash on deposit
If cash is placed on deposit the investor can choose when to disinvest and will receive interest additions during the time if investment
The interest additions will be subject to regular change as determined by the investment provider
The amounts and timing of cashflows will therefor be unknown
Equity shares
- Securities held by the owners of an organisation
- Shareholders are entitled to a share in the company’s profit, in proportion to the number of shares owned
- The distribution of share take the form of dividend, which are variable since they are related to the company’s profit
- Dividends are expected to increase over time as profits increase, but this is not guaranteed
- To construct a cashflow model assumptions needs to be made about the growth of future dividends
- The cashflows are uncertain
Annuity-certain
- Provides a series of regular payments in return for a single premium paid at the outset
- The precise conditions under which the annuity pays will be clearly specified
- The payments amounts may be level of specified to vary - eg in line with inflation or at a constant rate
- The cashflow for the investor will be an initial negative cashflow followed by a series of smaller regular positive cashflows throughout the the specified term of payment
Interest-only loan
- A loan that is repayable by a series of interest payments followed by a return of the initial loan amount
- The interest rate need not be fixed in advance - The regular cashflow may therefor be unknown in amounts
- It is also for the loan to be repaid early - Therefor the number of cashflows and the timing of the final repayment may be uncertain
Repayment loan (Mortgage)
- A loan that is repayable by a series of payments that include partial repayment of the loan capital in addition to the interest payments
- In its simplest form, the interest rate will be fixed and the payments will be of fixed equal amounts, paid at regular known times
- The repayment can be split into interest and capital changes over the period of the loan.
- The first payment will consist almost entirely of interest and will provide only a small capital repayment, while the last payment will consist of almost only capital repayment and very little interest
Pure Endowment
- An insurance policy which provides a lump sum benefit on survival to the end of a specified term usually in return for a series of regular premiums
- The cashflows will be a regular series of negative cashflows throughout the specified term of until death, if earlier. A large positive cashflow occurs at the end of the term if the policyholder survives until then
- In some cases a lump sum premium is paid
Endowment assurance
- An insurance policy which provide a survival benefit at the end of the term, but also provides a lump sum benefit on death before the end of the term
- The benefit are provided in return for a series of regular payments
- The cashflows will be a regular series of negative cashflows throughout the specified term of until death, if earlier, followed by a large positive cashflow at the end of the term or at death (if earlier)
Term assurance
- An insurance policy which provides a lump sum benefit on death before the end of a specified term usually in return for a series of regular premiums
- The cashflows will be a regular series of negative cashflows throughout the specified term of until death, if earlier, followed by a large positive cashflow at death (if earlier)
Contingent annuity
- Similar to a annuity certain, but the payments are contingent upon certain events, such as survival, hence the payment term for the regular cashflows is uncertain
Typical examples of contingent annuities
- Single life annuity - Where the regular payments made are contingent of the survival of the annuitant
- Joint life annuity - Covers 2 lives, where the regular payments made are contingent of the survival of one or both annuitants
- A reversionary annuity - Based on 2 lives, where the regular payments start on the death of the first life, if and only if, the second annuitant is alive at that time - Payments then continue until the death of the second annuitant
Car insurance policy
- Typically lasts for one year
- In return for a premium which can be paid as a single lump sum or at monthly intervals, the insurer will provide cover to pay for damage to the insured vehicle or fire or theft of the vehicle, known as “property cover”
- In many countries car insurance policies also provide liability cover - cover for compensation payable to third parties for death, injury or damage to property
- Depending on the terms of the policy, the insurance company may settle claims directly with the policyholder or with another party
- In some cases the policyholder may be required to cover the cost of damage or repairs first before the insurance company settles the claim, in which case the insurance company will pay the policyholder directly
- Cashflows tend to be short-term and payable within the year
Health-Cash Plan
- A typical health insurance contract lasts for one year
- In return for a premium, the policyholder is entitled to benefits which may include hospital treatment either paid for in full or in part, and or cash benefits instead of treatment, such as a fixed sum per day spent in hospital as an in-patient
- The cashflows will include a negative cashflow at the beginning of the year followed by positive cashflows in the event of a claim in the case of a bash benefit.
- When the insurance company pays for the treatment directly the policyholder may experience no more cashflows after paying the initial premium
- Cashflows tend to be short-term and payable within the year
