Key Review for Midterm - Simple Loan Interest Rate PV of...

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Simple Loan Interest Rate: PV of loan= FV/(1+i), and solve for I; Current yield= approximation for YTM, easier to calculate. i= C/P Coupon Bond= pays owner fixed interest payment every year until maturity when final amount (face value) is repaid Discount Bond= Value of bond and yield to maturity are negatively related and if I increases, the PV of any given cash flow is lower, and price of bond must be lower; Yield to Discount :(F-P)/F x (360/days to mat) where F is future value and P is price. Longer maturity of bond: longer duration. & higher int. rate: shorter duration; %ΔP=percent change in market value=-DUR*(Δi/1+i); formula for SD=sqrt(p1(R1-Re)^2+… Shift in demand curve: wealth(↑↑), Expected interest rate(↓↑), risk of bonds(↓↑), liquidity(↑↑); Expected return for demand curves: (F-P)/P Shift in supply curve: profitability of investments(↑↑), expected inflation(↑↑), gov’t deficit(↑↑) If expected inflation goes up, bond demand decreases but bond supply increases If forecast interest rate is ↑, buy short bonds. And if going down, buy long. If forecast interest rate is ↑, borrow long.if going down, borrow short. In business cycle with growing wealth, demands for bonds rises, and higher expected future interest rates decrease demand for bonds Factors that influence interest rate: risk of default: occurs when issuer of bond is unable to make interest payments as promised. and bonds with no default risk are called default-free bonds, ex: treasury bonds. Risk Premium: spread between interest rate of bonds with default risk and risk free. A bond with default risk will always have positive premium. More liquid the asset it is, higher demand for it. Muni bonds - lower rate than treasuries because they are less liquid and can default. Tax exemptions on municipal bonds raises relative expected return. issued by local, county and state. Used to finance public interest projects. Two
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