chapter 10: understanding interest rates

Question 1

yield to maturity

Answer 1

the most accurate measure of interest rates

what economists mean when they use the term interest rate

Question 2

streams of cash payments to the holder

Answer 2

cash flows

Question 3

present value or present discounted value

Answer 3

based on the commonsense notion that a dollar paid to you one year from now is less valuable to you than a dollar paid to you today

Question 4

In this loan, the lender provides the principal that must be repaid to the lender at the maturity date along with an additional payment for the interest

Answer 4

a simple loan

Question 5

simple interest rate

Answer 5

the interest payment divided by the amount of the loan

Question 6

The process of calculating today’s value of dollars received in the future

Answer 6

discounting the future

using PV

FV

Question 7

forumla to calculate PV

Answer 7

PV = FV / (1 + i)^n

Question 8

four basic types of credit market instruments

Answer 8

A simple loan

fixed-payment loan (fully amortized loan)

a coupon bond

A discount bond

Question 9

fixed-payment loan (fully amortized loan)

Answer 9

the lender provides the borrower with an amount of funds, which must be repaid by making the same payment every period (such as a month)

must pay the debt service you already know

Question 10

a coupon bond

Answer 10

pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturity date

at the maturity date, a specified final amount is repaid

Question 11

face value or par value of a bond

Answer 11

amount you have to repay at the maturity date

Question 12

three pieces of information that define a bond

Answer 12

1. the corporation or government agency that issues the bond
2. the maturity date of the bond
3. the bond’s coupon rate

Question 13

the bond’s coupon rate

Answer 13

the dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond

Question 14

A discount bond (also called a zero-coupon bond)

Answer 14

bought at a price below its face value (at discount)

the face value is repaid at the maturity date

Question 15

bond bought at discount

Answer 15

bought at a price below its face value

Question 16

most important way of calculating interest rates

Answer 16

the yield to maturity

Question 17

the yield to maturity

Answer 17

the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today

the internal rate of return required for the present value of all the future cash flows of the bond (face value and coupon payments) to equal the current bond price

Question 18

for which loan does the simple interest rate equals the yield to maturity?

Answer 18

for the simple loan

Question 19

formula of loan with payment to give (present value)?

Answer 19

LV = PMT * (1 - (1 + r)^(-n))/r

LV = loan value

Question 20

formula of coupon bond

Answer 20

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

C = yearly coupon payment

F = face value of bond

P = price of bond

Question 21

when the the yield to maturity equals the coupon rate of a coupon bond, whats its price?

Answer 21

coupon bond priced at its face value

Question 22

when the the yield to maturity is greater than the coupon rate of a coupon bond, whats its price?

Answer 22

the bond price is below its face value

Question 23

when the the yield to maturity is below than the coupon rate of a coupon bond, whats its price?

Answer 23

the bond price is above its face value

Question 24

what do we mean when we say that he price of a coupon bond and the yield to maturity are negatively related?

Answer 24

as the yield to maturity rises, the price of the bond falls

As the yield to maturity falls, the price of the bond rises

Question 25

consol or a perpetuity

Answer 25

a perpetual bond with no maturity date and no repayment of principal that makes fixed coupon payments of $C forever

Question 26

formula of perpetuity

Answer 26

Pc = C / ic Pc = price of perpetuity C = yearly payment ic = yield to maturity

Question 27

current yield

Answer 27

the yearly coupon payment divided by the price of the security ic = C / Pc Pc = price of perpetuity C = yearly payment ic = yield to maturity

Question 28

The yield-to-maturity calculation for a discount bond

Answer 28

similar to that for the simple loan PV = FV / (1 + i)^n

Question 29

rate of return

Answer 29

For any security, the rate of return is defined as the payments to the owner plus the change in its value expressed as a fraction of its purchase price

Question 30

will the return on a bond necessarily equal the yield to maturity on that bond?

Answer 30

nah bruuuv the distinction between interest rate and return can be important

Question 31

formula for rate of return on a coupon bond

Answer 31

RET = (C + Pt+1 - P1) / (Pt) RET + return from holding the bond from time t to time t + 1 ``` Pt = price of the bond at time t Pt+1 = price of the bond at time t + 1 C = coupon payment ``` RET = (C / P) + ((P+1 - P) / P) first term C/P is the current yield ic (the coupon payment over the purchase price) The second term is the rate of capital gain RET= ic + g g = he rate of capital gain

Question 32

what does a rise in interest mean for someone holding a bond?

Answer 32

the price of the bond has fallen if he sells it then, it will result in a capital loss

Question 33

what does the finding that the prices of longer-maturity bonds respond more dramatically to changes in interest rates explain?

Answer 33

prices and returns for long-term bonds are more volatile than those for shorter-term bonds long term bonds are riskier

Question 34

interest-rate risk

Answer 34

the riskiness of an asset s return that results from interest-rate changes

Question 35

which have a more important interest-rate risk, long term or short term bonds?

Answer 35

long term bonds

Question 36

which types of bonds have no interest-rate risk? why?

Answer 36

any bond whose time to maturity matches the holding period the price at the end of the holding period is already fixed at the face value he change in interest rates can then have no effect on the price at the end of the holding period for these bonds he return will therefore be equal to the yield to maturity known at the time the bond is purchased

Question 37

nominal interest rate

Answer 37

interest rate disregarding inflation rate

Question 38

real interest rate

Answer 38

the interest rate that is adjusted by subtracting inflation it more accurately reflects the true cost of borrowing

Question 39

ex post real interest rate

Answer 39

The interest rate that is adjusted for actual changes in the price level Nominal interest rate - inflation rate describes how well a lender has done in real terms after the fact

Question 40

real interest rate equation (Fisher equation)

Answer 40

i = ir + pi^e i = nominal interest rate ir = real interest rate pi^e = expected rate of inflation ir = i - pi^e

Question 41

indexed bonds

Answer 41

interest and principal payments are adjusted for changes in the price level

Question 42

Ex ante real interest rate

Answer 42

Nominal Interest rate - expected inflation rate