chapter 10: the meaning of interest rates

Question 1

present value meaning?

Answer 1

a dollar paid to you one year from now is less valuable than a dollar paid to you today

Question 2

simple interest rate example?

Answer 2

the interest rate of a simple loan

Loan $100 today and require $110 repayment in one year

The simple interest rate is 10%

Question 3

Simple Present Value formula

Answer 3

PV = FV / (1 + i)^n

Question 4

simple loan

Answer 4

One payment at the maturity date

Question 5

Fixed Payment Loan

Answer 5

Multiple fixed payments at pre-specified dates

Question 6

Coupon Bond

Answer 6

A bond that pays fixed amounts (the coupons) at fixed dates

plus a final payment (the face value) at maturity

Question 7

discount bond

Answer 7

A bond that pays zero coupons, only a final payment at maturity

“Discount” since price typically less than face value.

Question 8

Four Types of Credit Market Instruments

Answer 8

1. Simple Loan
2. Fixed Payment Loan
3. Coupon Bond
4. Discount Bond

Question 9

the most important way to calculate interest rates?

Answer 9

the yield to maturity

Question 10

the yield to maturity

Answer 10

the interest rate that equates the present value of all cash flow payments received from a debt instrument with its value today (the current price)

Question 11

yield to maturity example with simple loan: If today’s value is $100 and the payment due in one year’s time is $110, what is the yield to maturity

Answer 11

then the yield to maturity is 10%

Question 12

fixed payment loan formula

Answer 12

PV = PMT · (1-(1 + i)^n) / i

Question 13

coupon bond formula

Answer 13

C / (1 +i)^n + F / (1 +i)^n = P

P = price of coupon bond

C = yearly coupon payment

F = face value of the bond

n = years to maturity

Question 14

Three Facts About Coupon Bonds

Answer 14

1. When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate
2. The price of a coupon bond and the yield to maturity are negatively related
3. The yield to maturity is greater than the coupon rate when the bond price is below its face value

Question 15

Consol or Perpetuity formula

Answer 15

Pc = price of the consol

C = yearly interest payment

ic = yield to maturity of the consol

ic = C/Pc

Question 16

Consol or Perpetuity definition

Answer 16

A bond with no maturity date that does not repay principal but pays fixed coupon payments forever

Question 17

interest of discount bound formula

Answer 17

i = (F - P) / P

Question 18

rate of return

Answer 18

How well a person does financially by holding a bond for some period of time

The return (R) depends on coupons received (C) and the price for which the bond is eventually sold

Question 19

what is the formula for the return that depends on coupons?

Answer 19

R = C/Pt + (Pt+1 - Pt)/Pt

C/Pt = current yield = ic

(Pt+1 - Pt)/Pt = rate of capital gain = g

Question 20

when does the return equal equals the yield to maturity?

Answer 20

only if the holding period equals the time to maturity

Question 21

what does a rise in interest rate mean in a bond price? does it lead to capital gain or loss if time to maturity is longer than holding period?

Answer 21

with a fall in bond prices

results in a capital loss

Question 22

when is the size of the percentage price change increasingly associated with an interest-rate change

Answer 22

The more distant a bond’s maturity

Question 23

an increase In interest rate will bring a bigger or larger rate of return when the bond’s maturity is most distant?

Answer 23

The more distant a bond’s maturity, the lower the rate of return the occurs as a result of an increase in the interest rate

Question 24

can a bond’s return be negative if the interest rate rises?

Answer 24

yes

Question 25

interest-rate risk

Answer 25

The risk level associated with an asset’s return that results from interest-rate change

Question 26

what has more interest risk?

Answer 26

long-term bonds

Question 27

which types of bonds has no interest-risks

Answer 27

any bond whose time to maturity matches the holding period

Question 28

Nominal interest rates

Answer 28

make no allowance for inflation

Question 29

real interest rates

Answer 29

adjust for changes in price level

more accurately reflects the cost of borrowing

Question 30

Ex ante real interest rate

Answer 30

is adjusted for expected changes in the price level

Question 31

Ex post real interest rate

Answer 31

is adjusted for actual changes in the price level

Question 32

Fisher Equation

Answer 32

i = r + pi^e

Question 33

according to the fisher equation, when do you have more I centavos to borrow?

Answer 33

when interest rates are low

Question 34

when do lenders have less incentive to lend according to fisher’s equation?

Answer 34

when interest rates are low