RSM332H1 Midterm: midterm summary (2)
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1. Time-value of money
1.1 Single Cash flow
i) Present value and future value
ii) Compounding frequency
for yearly, semi-annually, quarterly,
for continuous compounding
e.g., stock price process
iii) Effective annual rate (EAR): what would be the
interest rate if an investment gives you an annual
1.2 Multiple Cash flow
i) Growing annuity
Note: This is the value of all future cash flows one period
before is generated. is not a cash flow today.
: Used for mortgages (Be careful about the convention
quote semi annul rate *2 and monthly compounding.
Adjust r and T in the formula), to value a level coupon
iii) Growing perpetuity
1.3 Etc: Simple interest VS compound, NPV
2. Bond valuation
2.1 Three types of bonds by payment structure
i) Level-coupon bond price
where is the coupon payment (Face value x coupon
Note: If you are dealing with semi-annual coupon, you
have to adjust .
Ex) 5% discount rate, 6% coupon rate, 5-year maturity.
C = 1,000*0.06/2, r=0.05/2, T = 5*2
ii) For zero coupon,
iii) For zero face value,
i) Bond VS stock:
a) Bond gives you predetermined cash flows vs cash
flows are uncertain from stock
b) legal obligation vs ownership
ii) Holding period return: (Selling price + coupon
buying price)/buying price
iii) YTM: aggregates all characteristics of a bond which
affec ineor illingne o b he bond eg
inflation, liquidity, credit risk)
iv) Duration : effectively how long does it take to recover
Æ mathematically related to a slope for a
percent change in the bond price. Duration captures
interest rate risk.
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