Textbook Notes (367,844)
Canada (161,454)
Economics (1,068)
EC223 (81)
Chapter 4

Chapter 4 EC223.docx

3 Pages
95 Views
Unlock Document

Department
Economics
Course
EC223
Professor
Angela Trimarchi
Semester
Winter

Description
EC223 Chapter 4 – Understanding Interest Rates Week 4 Measuring Interest Rates -Different debt instruments have very different streams of cash payments to the holder – known as cash flows – with very different timing Present Value -Based on the fact that a dollar paid to you one year from now is less valuable to you than a dollar paid to you today -Simple loan – the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for interest PV = Current value n (1 + i) -The concept of present value allows us to figure out today’s value (price) of a credit market instrument at a given simple interest rate, I, by just adding up to the individual present values of all the future payments received Four Types of Credit Market Instruments 1. A simple loan – the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date along with an additional payment for the interest 2. A fixed-payment loan – the lender provides the borrower with an amount of funds, which must be repaid by making the same payment every period consisting of part o the principal and interest for a set number of years 3. A coupon bond – pays the owner of the bond a fixed interest payment every year until the maturity date, when a specified final amount (face value) is repaid. The bond’s coupon rate is the dollar amount of the early coupon payment expressed as a percentage of the face value of the bond 4. A discount bond – bought at a price below its face value and the face value is repaid at the maturity date Yield to Maturity -The interest rate that equates the present value of cash flow payments received froma debt instrument with its value today Simple Loan PV = Cash flow in one year n (1 + i) -The simple interest rate equals the yield to maturity Fixed-Payment Loan -The borrower makes the same payment to the bank every month until the maturity date, when the loan will be completely paid off -We equate today’s value of the loan with its present value LV = Fixed payment + Fixed payment + Fixed payment + ….. + Fixed payment 2 3 n (1 + i) (1 + i) (1 + i) (1 + i) Coupon Bond -Same strategy used for the fixed-payment loan: equate today’s value of the bond with its present value P = Coupon payment + Coupon payment + Coupon payment + ….. + Coupon payment (1 + i) (1 + i)2 (1 + i) (1 + i) EC223 Chapter 4 – Understanding Interest Rates Week 4 -Three facts emerge: -When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate -The price of a coupon bond and the yield to maturity are negatively related; that is, as the yield to maturity rises, the price of the bon falls. As the yield to maturity Falls, the price of the bond rises -The yield to maturity is greater than the coupon rate when the bond price is below its face value -These three facts are true for any coupon bond -Bond price and the yield to maturity are negatively related -When the yield to maturity equals the coupon rate, the bo
More Less

Related notes for EC223

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit