Chapter # 4

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