Cash flow mapping

We ll get into money and the way you and your business relate to it in more detail in spring, but for the purpose of creating a map, we re talking about an overview, a snapshot of how well greased the mechanics of your business are. This is the part where you consider and plan your income projections and cash flow. This shouldn t become an Alan Greenspan-type document addressing the nation about financial forecasts. Keep it simple and truthful. Money is such a liquid thing that it s hard to try to pin it down sometimes, and it could seem the more you try to get a solid hold—without a couple years experience behind you—the more elusive it becomes. Just try to be as honest with yourself as possible as you project into the future what you already know you can and cannot commit to financially. 

We now revisit the earlier Vasicek example for short interest rates to consider the case where the underlying bond pays an annual coupon at a 5% rate (p = 0.05), all the other characteristics remain as before. In order to calculate the call price of the coupon-bond European option first we need to calculate the interest rate such that the present value at the maturity of the option of all later cash flows on the bond equals the strike price. This is done by trial and error using equation (18.48) and the value we get here is = 22.30%. Next, we map the strike price into a series of strike prices via equation (18.50) that are then associated with coupon payments considered as zero-coupon bonds and calculate the value of the European call options contingent on those zero-coupon bonds as in the above example. The calculations are described in Exhibit 18.7. 

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