Chapter 4

Chapter 4: Understanding Interest Rates
Measuring interest rates
Debt instruments have very different streams of cash payments to the holder with very different timing.
Present value
Concept basedon the commonsense notion that a dollar paid to you one year from now is less valuable to you that a dollar paid to you today.
The process of calculating today’s value of dollars received in thefuture, as que have done above, is called discounting the future.
PV=CF(1-i)n
Four types of credit market instruments
1. Simple loan: be repaid to the lender at the maturity date along with anadditional payment for the interest.
2. A fixed-Payment loan or fully amortized loan: must be repaid by making the same payment every period, consisting of part of the principal and interest for a setnumber of years.
3. A coupon bond: pays the owner of the bond a fixed interests payment or coupon payment every year until the maturity date, when a specified final amount (face value or par value) isrepaid.
a. Coupon bond identified by:
* Corporation or government agency that issues the bond
* Maturity date of the bond
* Bonds coupon rate
4. Discount bond orzero-coupon bond: bought at a price below its face value( at a discount) and the face value is repaid at the maturity date.
Yield to maturity
Interest rate that equates the present value of cash flowpayments received from a debt instrument with its value today. The key to understanding calculation is equating today’s value of the debt instrument with the present value of all its future cash flowpayments.
1. Simple loans: the simple interest rate equals the yield to maturity.
2. Coupon bond:
a. Priced at its face value, the yield to maturity equals the coupon rate
b. Price ofa coupon bond and the yield to maturity are negatively related, yield to maturity rises coupon price falls.
c. The yield to maturity is greater than the coupon rate when the bond price is...