Chapter 4: The Meaning of Interest Rates Flashcards
Present value
a dollar paid to you one year from now is less valuable than a dollar paid to you today
Yield to maturity
the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
What are the four types of credit market instruments?
- simple loan
- fixed payment loan
- coupon bond
- discount bond
Simple loan YTM formula
PV = CF / (1+i)^n
Fixed Payment Loan YTM formula
LV = FP/(1+i) + FP/(1+i)^2 + … + FP/(1+i)^n
Coupon Bond YTM
P = C/1+i + C/(1+i)^2 + … + C/(1+i)^n + F/(1+i)^n
Rate of return formula
RET = C/P_t + (P_t+1 - P_t)/P_t
current yield
C/P_t
rate of capital gain
(P_t+1 - P_t)/P_t
Perpetuity YTM formula
P = C/1+i + C/(1+i)^2 + … = C/i
discount bond YTM
P = F/1+i^n
Fisher equation
i = r + pi
simple loan
pay off at maturity date
fixed payment loan
the borrower must repay by making the same payment, consisting of part of the principal and interests, every period, for a set number of years
coupon bond
pays a fixed interest payment every year until the maturity date, when a specified final amount is repaid
discount bond
bought at a price below its face value and the face value is repaid at the maturity date
what is the relationship between interest rates and bonds?
as interest rates increase, bond prices decreases
ceteris paribus
with everything else held constant
