RSM332H1 Lecture 4: Class 4
Document Summary
We care about real return because of purchasing power. Nominal rate is known today, but not rreal and i. Fisher"s theor(cid:455): whe(cid:374) e(cid:894)rreal(cid:895) is co(cid:374)sta(cid:374)t, cha(cid:374)ge i(cid:374) (cid:374)o(cid:373)i(cid:374)al rate is due to cha(cid:374)ge i(cid:374) e(cid:454)pected i(cid:374)flatio(cid:374) With this, we can use t-bills to hedge against inflation. The nominal rates in t-bill reflect the inflation when traders are calculating. Long-term bonds accrue a lot of inflation risk. Bond valuation basics: maturity (fixed lifetime, coupon payments (semi-annual payments, face value (or par value, risk characteristics (credit, inflation risks) This type of interest rate is called a spot rate. Case 2: general situation where the rates for different periods are different. T-note (with maturity between 2 to 10 years) So the rate for six months should be 4% If coupon/face value > r, then p0(c) > f. In case 2, we cannot use annuity since they have different interest rates. Coupon rates are bond specific but spot rates are market-wide.
