class 2 Flashcards
what is interest rate?
the promised price paid for the rental of funds
what can we consider the interest rate as?
the exchange rate across time
why can we consider interest rate the exchange rate across time?
because that is rate you have to pay to exchange future funds in to current funds or the rate you get when you exchange current funds into future funds
what is present value?
the current value of a future cash flow
what is future value?
the amount a cash flow will grow over time
what is compounding?
the way to determine the future value of a cash flow today
what are the 4 timing of cash flow payments?
simple loan
fixed payment loan
cupon bond
discount bond
what is a simple loan?
one payment at a maturity date
what is an example of a simple loan?
if I take out a loan for 100 dollars and in one year I have to pay 150 dollars
what is a fixed payment loan?
multiple fixed payments at specified dates and no lump sum payment at maturity
what is an example of a fixed payment loan?
a mortgage, pay a certain amount monthly or bi monthly until it is payed off
what is a coupon bond?
a bond that pays fixed amount (the coupons) at fixed dates, plus a final payment of the face value at the maturity
is the price of a coupon bond equal to its face value?
no typically not
what is a discount bond?
a pond that pays 0 coupons (payments), only pays a finial payment at its maturity date (similar to a simple loan)
what is another term for a discount bond?
zero coupon bond
the canadian government has just issued a 10 year $1000 bond with a 4% coupon and semi annual payments, what cash payments (cash flow) will you receive if you hold the bond until maturity?
20 dollars every 6 months for 10 years and the 1000 dollar face value at maturity
what is an example of zero coupon bonds?
treasury bill
what price do zero coupon bonds sell at?
they sell at a cheaper price than their face value
what is yield to maturity?
the expected interest rate per period if you buy a debt instrument at a current price and hold it to the maturity
what equates the present value of all cash flow payments of a debt instrument with its value today?
intrest rate
what is the formula for simple loans?
PV=CF/ (1+i)^n
if the current price of a bond is higher than the face value how does that impact the yield to maturity?
the interest or yield to maturity goes down
if the current price of a bond is lower than the face value how does that impact the yield to maturity?
the interest or yield to maturity goes up
if the current price of the bond is equal to the face value how does that impact the yield to maturity?
the yield to maturity is equal to the coupon rate
how are the price of a coupon bond and the yield to maturity related?
they are negatively related
when does the return of a bond equal the yield to maturity?
only if the holding period equals the time to maturity
even if a bond has a substantial initial interest rate, can the return still be negative?
yes it can be negative if interest rates rise
if the time to maturity is longer than the holding period in a situation where a rise interest rates are associated with a fall in bond prices, how will that impact you?
you will receive a capital loss on that investment
what are nominal interest rates?
the rates quoted by financial institutions, the rates at which your money will grow if invested for a certain period and don’t adjust for inflation
what are real interest rates?
the rate of your purchasing power after adjusting for inflation and more accurately reflects the cost of borrowing
what is the fisher equation?
R= nominal intrest rate - expected inflation rate
