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Unformatted text preview: 1 Econ 102 Fall 2006 Lecture 6 Present Value 2 Topics • Real and nominal interest rates • The Fisher equation • How to value an asset 3 Interest • Two periods • One good • Borrowing and lending • No uncertainty • B R is a real bond 4 Budget Constraints 1 1 R B Y C = ( 29 2 2 1 R C Y r B = + + 2 2 1 1 1 1 C Y C Y r r + = + + + Today Tomorrow Lifecycle 5 Two Period Model Today Tomorrow The real rate of interest is the price of a good today relative to a good tomorrow Lending 6 Two Period Model Today Tomorrow Borrowing r is the real rate of interest 7 Absence of Arbitrage 1 1 qB A Y C + = ( 29 2 2 1 C Y r A B = + + + 2 2 1 1 1 1 1 1 C Y C Y B q r r r + = + + + + + Absence of arbitrage implies this is zero 8 Some Definitions • i is the nominal interest rate • r is the real interest rate • p 1 is the price of a good at date 1 • p 2 is the price of a good at date 2 • B is a nominal bond • B R is a real bond 9 Money and Interest 1 1 1 1 B pY p C = ( 29 2 2 2 2 1 p C p Y i B = + + ( 29 ( 29 2 2 2 2 1 1 1 1 1 1 1 1 p C p Y C Y p i p i + = + + + 10 Absence of Arbitrage 1 1 1 1 1 R p B B pY p C + = ( 29 ( 29 ( 29 ( 29 2 1 2 2 2 1 2 2 2 1 1 1 1 1 p r C...
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 Fall '08
 Serra
 Macroeconomics, Interest Rates, Debt, Nominal Interest Rate, Arrow securities

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