Present Value:
dollar paid to you one year from now is less valuable than that dollar paid to you today
Discounting the Future
Process of calculating today's value of dollars received in the future
Four Types of Credit Market Instruments:
1. Simple Loans
2. Fixed Payment Loan (fully amortized)
3. Coupon Bond
4. Discount Bond
1. Simple loans
lender provides borrower with funds, which are repaid at maturity date plus interest
2. Fixed payment loan
lender provides borrower with funds, which are repaid by making same pmt every period, consisting of part of principal and interest
3. Coupon Bond
pay owner of bond fixed pmt every year until maturity date when final amt is repaid.
4. Discount bond
bought at a price below its face value and is repaid at maturity date
- no interest rate payments are made
Yield to Maturity:
interest rate that equates present value of a cash flow payment received from a debt instrument with its value today.
special type of coupon bond
perpetuity
Perpetuity
perpetual bond with no maturity date and no repayment of principal and makes fixed coupon pmt for ever
Perpetuity Formula:
C/i,
or i = C/p
Current yield defined as:
C/P
Rate of Return
payments to owner plus change in value, expressed as a fraction of a purchase price
- prices and returns for long term bonds are more volatile than those for shorter bonds
Interest Rate:
riskiness of an asset's return that results from interest rate changes
Nominal Interest rtes:
when inflation is higher than nominal interest rate, regative real interest rate