Chapter 3: Time Value of Money Flashcards

1
Q

Simple vs. Compounded interest

A

Simple: interest due along with amount borrowed (principle) at the end of loan period. (Amount owed, F=P[1+i*n])
Compounded: interest due at the end of each period, amount based on amount owed at the beginning of period.

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2
Q

Effective interest rate

A

Rate which if compounded once per standard period yields same F as nominal compounded m times per period.
EIR=(F-P)/P=[1+(r/m)]^m-1
r=nominal int rate
m=number of compounding period per year

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3
Q

Nominal interest rate

A

Interest rate per standard period of time. AKA: nominal annual rate unless otherwise specified

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4
Q

Continuous compounding

A

Compounding occurs infinitely. EIR=e^r-1
Replace all (1+i)^n in factors with e^(r*n)

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5
Q

Infinite time period

A

(F/P)=(F/A)=inf
(P/F)=(A/F)=0
(P/A)=1/I
(A/P)=i

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6
Q

Time has no value (i=0)

A

(F/P)=1
(F/A)=n
(A/F)=1/n

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7
Q

Interest changes over time

A

(F/P, i, n): (1+i1)(1+i2)..(1+in)

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8
Q

End of period changes

A
  1. Increasing/decreasing by constant amount per time
  2. Increasing/decreasing by constant rate per time
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9
Q

BOND CERTIFICATE

A

states terms of bond

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10
Q

MATURITY DATE

A

final repayment date
N

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11
Q

TERM

A

time remaining until repayment date

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12
Q

COUPON RATE

A

nominal interest rate applied to bond’s face value
> PMT

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13
Q

FACE VALUE

A

monetary value indicated on bond and received at maturity, when bond is redeemed
- FV

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14
Q

COUPON PAYMENT

A

CPN=(CRxFV)/(# coupon payment per year)

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15
Q

COUPON BOND

A
  • pay face value at maturity
  • pay coupon interest payments
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16
Q

YIELD TO MATURITY

A
  • interest rate earned on the amount invested, specified as nominal interest rate
  • discount rate that sets PV of promised bond payment equal to current market price of bond
17
Q

DISCOUNT

A
  • bond sells at discount if the price is less than face value
  • investor earns return from receiving coupon and from receiving face value that exceeds price paid for bond
    CR < YTM
18
Q

PAR

A
  • bond sells at par if the price is equal to face value
    CR = YTM
19
Q

PREMIUM

A
  • bond is selling at premium is price is greater than face value
  • will earn return from coupon but return is diminished from face value less than price paid for bond
    CR > YTM
20
Q

Sharpe Theory #1

A

bond pulses economy
YTM increases: present value decreases
YTM decreases: present value increases

21
Q

Sharpe Theory #2

A

premium decays until PV->Par until end of contour at REDEMPTION DATE
discount increases until PV->Par

22
Q

Sharpe Theory #3

A

YTM increases: risk of default increases
Bond: government, corporate, junk

23
Q

Sharpe Theory #4

A

YTM increases: Present value decreases
x>y

24
Q

Sharpe Theory #5

A

INTEREST RATE GYRATION: at larger periods of time, there is higher sensitivity to YTM changes (higher % change)

25
Q

Sharpe Theory #6

A

higher coupon rate=lower sensitivity to INTEREST RATE GYRATION (lower % change)