Lecture 2 Flashcards
zero-coupon bond
promises a single cashflow, face value (or par value), at some future date, maturity.
Coupon
The annual interest rate paid on a bond, expressed as a percentage of the face value.
It is also referred to as the “coupon rate,” “coupon percent rate” and “nominal yield.
coupon bond
promises a periodic cashflow, coupon, and the face value at maturity. The coupon rate is the ratio of the coupon to the face value. Coupon payments are typically semiannual for US bonds and annual for European bonds.
Treasury Bills (T-Bills)
Maturities up to 1 year. No coupon.
Treasury Notes (T-Notes):
Maturities between 1 and 10 years. Semiannual coupon.
Treasury Bonds (T-Bonds):
Maturities greater than 10 years. Semiannual coupon.
Discount factor calculation
Spot rate
The price quoted for immediate settlement on a commodity, a security or a currency. The spot rate, also called “spot price,” is based on the value of an asset at the moment of the quote. This value is in turn based on how much buyers are willing to pay and how much sellers are willing to accept, which depends on factors such as current market value and expected future market value. As a result, spot rates change frequently and sometimes dramatically.
Expectation theory
The Expectations Theory – also known as the Unbiased Expectations Theory – states that long-term interest rates hold a forecast for short-term interest rates in the future. The theory postulates that an investor earns the same amount of interest by investing in a one-year bond in the present and rolling the investment into a different one-year bond after one year as compared to purchasing a two-year bond in the present.
Liquidity preference theory
Suggests that an investor demands a higher interest rate, or premium, on securities with long-term maturities, which carry greater risk, because all other factors being equal, investors prefer cash or other highly liquid holdings. Investments that are more liquid are easier to sell fast for full value. According to the liquidity preference theory, interest rates on short-term securities are lower because investors are sacrificing less liquidity than they do by investing in medium-term or long-term securities.
Zero-coupon bond
A zero-coupon bond, also known as an “accrual bond,” is a debt security that doesn’t pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value.
Current Yield
Bonds - what did we learn so far
Yield to Maturity (YTM)
The total return anticipated on a bond if the bond is held until the end of its lifetime. Yield to maturity is considered a long-term bond yield, but is expressed as an annual rate. In other words, it is the internal rate of return of an investment in a bond if the investor holds the bond until maturity and if all payments are made as scheduled.
YTM of a Bond with Semiannual Coupons
Forward rate
Interpreting forward rates
