week 14

Question 1

what are interest rates per period

Answer 1

most straightforward
not on an annual basis

Question 2

what are stated annual interest rate / quoted rate

Answer 2

periodic compounding
most available rate
known as APR - the interest charged per period times the number of periods per year

Question 3

what is effective interest rate

Answer 3

most informative rate

Question 4

what is the frequency of compounding

Answer 4

investments pay more interest more than once a year,
semi-annual interest rate that compounds twice a year

Question 5

how can future value be expressed

Answer 5

PV (1 + (rs/m)) ^ mN
m is the number of compounding periods
N is number of years

Question 6

what is effective annual rate (EAR)

Answer 6

the actual rate paid after accounting for compounding that occurs during the year
used to compare two alternative investments with different compounding periods

Question 7

how do you calculate EAR

Answer 7

(1 + (APR / m))^m - 1

Question 8

how do you calculate APR from EAR

Answer 8

APR = m x ((1 + EAR) ^1/m -1)

Question 9

what are loan types

Answer 9

there are unlimited possibilities of how loan principal and interest is paid
pure discount loans
interest-only loans/bullet bonds
amortised loans (fully or partially)

Question 10

what are pure discount loans

Answer 10

the borrower receives money today and repays a single lump sum at end of the loan

Question 11

what are interest only loans

Answer 11

interest only loans require payment of interest each period and the repayment of the principal at a later date

Question 12

what are amortised loans

Answer 12

principal is repaid overtime
the amount of principal is decreasing overtime
as part of the principal gets repaid, interest is calculated only on the remainder of the principal
periodic payments = interest + repayment of a portion of the principal

Question 13

what are the two types of amortised loans

Answer 13

fixed principal
fixed payments

Question 14

what is an amortisation schedule

Answer 14

a table that describes the periodic payments as well as the interest and principal balance after each payment

Question 15

what is fixed principal

Answer 15

the principle balance is reduced by the same amount each period
the periodic payment is different each year

Question 16

what is fixed payment

Answer 16

the principal balance is reduced by a different amount each period, at the end of the last period the principal is reduced to 0
the periodic payment is fixed each year

Question 17

what are bonds

Answer 17

a debt instrument requiring the issuer to repay to the investors the amount borrowed plus interest over a specified period of time
issuers - the parties that borrow money and issue debt securities
investors - the parties that lend money to issuers by buying the debt securities
other parties - underwriters: investment banking firms that act as agents to distribute bonds to investors

Question 18

what is face value

Answer 18

a bond is normally an interest-only loan
the borrower will pay the interest every period, but none of the principal will be paid until the end of the loan
face amount, repaid at maturity, most of the time it is not equal to bond price

Question 19

what are coupons

Answer 19

periodic payments that issuers promise to make
usually constant, determined upon issue, usually expressed as a percentage of par value

Question 20

how do you calculate coupon payment

Answer 20

(coupon rate x par value) / number of coupon payments per year

Question 21

how do you calculate current yield

Answer 21

coupon / market price

Question 22

what is maturity

Answer 22

the number of years until the face value is paid
the maturity date of a bond refers to the date when the debt will cease to exist
bonds may be short term and long term
years to maturity

Question 23

what is yield to maturity

Answer 23

the yield to maturity is the interest rate investors want to earn on a bond
the investor holds the bond to maturity
the issuer makes all the coupon and principal payments in full on scheduled dates
the investor is able to reinvest coupon payments at the same yield

Question 24

how do you calculate bond pricing equation

Answer 24

C x (1- (1/(1+r)^t)) /r + F x (1/(1+r)^T)

Question 25

what are bond prices, the relationship between coupon and yield

Answer 25

YTM = coupon rate, par value = bond price
YTM > coupon rate, par value > bond price - discount bond
YTM < coupon rate, par value < bond price - premium bond

Question 26

what are bond price movements

Answer 26

passage of time - price of a bond changes as the bond approaches maturity
changes in interest rates - for a standard, option free board, the cash flows will not change during the life of a bond, any changes are reflected in price

Question 27

who cares about price changes of the bond

Answer 27

investors
issuers

Question 28

what is bond price convergence

Answer 28

bond value differs from par value before maturity
regardless of required yield, price converges toward par value as maturity approaches