Chapter 4 Outline

Chapter 4 Outline - Department of Economics So Chapter 4...

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Unformatted text preview: Department of Economics So Chapter 4: Understanding Interest Rates Econ 330: Money and Banking Fall 2007 Prof. Joseph Santos This outline draws from Frederic Mishkin’s Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation. Department of Economics So [1] Measuring Interest Rates • The concept of present value (or present discounted value) is based on the notion that a dollar paid to you one year from now is less valuable to you than a dollar paid to you yesterday. – This notion is true because you can deposit a dollar in a savings account that earns interest and have more than a dollar in one year. • The formula for the present value of a lump sum payable in n periods, when the simple interest rate is i, is: • The present value of a series of identical $C payments that are paid for n periods, is called the present value of an annuity. The formula for the present value of an annuity, when the simple interest rate is i, is: This outline draws from Frederic Mishkin’s Money, Banking and Financial Markets (2007) and, as such, contains copy written material. Please do not quote without proper citation. [1] Measuring Interest Rates [2] Four Types of Credit Instruments [3] How to Price a Coupon Bond [4] Yield to Maturity [5] Yields to Maturity vs. Bond Prices [6] Other Measures of Interest Rates [7] Interest Rates vs. Holding- Period Returns [8] Bond-Price Volatility vs. Maturity [9] Real vs. Nominal Interest Rates ( 29 n Sum Lump i FV PV + = 1 ( 29 +- × = n Annuity i i C PV 1 1 1 Department of Economics So [2] Four Types of Credit Instruments • A simple loan – the lender provides the borrower with an amount of funds, which the borrower repays with interest upon maturity. • A discount bond (or zero-coupon bond) – the lender provides the borrower with an amount of funds equal to the bond’s price; the borrower pays the lender a lump-sum payment (or face value) at maturity. • A fixed-payment loan (or fully-amortized loan) – the lender provides the borrower with an amount of funds, which the borrower repays with interest in identical installments for a set number of periods. • A coupon bond – the lender provides the borrower with an amount of funds equal to the bond’s price; the borrower pays the lender fixed (coupon) payments until maturity, and a lump-sum payment (or face value) at maturity....
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Chapter 4 Outline - Department of Economics So Chapter 4...

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