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study guide test 2.docx - Interest Rates Pt 1 Spread the...

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Interest Rates Pt. 1 Spread- the difference between 2 interest rates BP- Basis Point- .01% = 1 BP 25% = .25% = 25 BP Interest rates change over time. Interest Rates Pt. 4 Real- adjusted for inflation Nominal- opposite of real. Nominal interest rate- interest before inflation adjustment if the bank pays you 2% while the cost of goods rises by 5%, you didn’t get ahead of where you originally were. In fact, you fell behind. The real , or after-inflation, rate of interest you earned was negative. Nominally you earned 2% on your money, but when you take inflation into account, you did not improve your situation by 2%. You actually lost money when taking inflation into account. In other words, you earned a negative real rate of interest. R = r* + IP or interest rate= inflation premium + real risk-free rate Projections for inflation for the next few years are as follows: year 1 2% year 2 3% year 3 5% Calculate (and show your work) the inflation premium for a 2-year bond -- in other words, what is the average annual inflation over this bond's life? 2+3 /2 = 2.5 Calculate (and show your work) the inflation premium for a bond maturing in 3 years -- in other words, what is the average annual inflation over the life of this bond? 2+3+5 / 3 = 3.33 To get bond for however many years inflation rates you add the interest rate for those amount of years (can change after certain amount of years) then divide that number by the years. Go 2 decimals out Components of Return Pt. 1 Return = profit 2 ways to measure Return in $
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Return in % Income- periodic cash flow from the investment/ regularly accruing Interest = principal X interest rate X fraction of a year Dividends- distribution of corporation’s net income to shareholder’s/ don’t have to pay Board of directors- decide if dividends paid or not. Protect interests of stockholder’ Components of Return Pt. 2 Growth (appreciation, capital gain)- increase in value of investment. Buy low sell high. Capital loss- decrease in value of investment. Total return= income + growth What does total return mean Components of Return Pt. 3 Return in $- Initial investment = shares X $ + commission Amount received = shares X $ - commission = amount received from investment– initial investment = return in $ Return in %- rate of return. Non annualized = return in $ / initial investment = return in % Gold bullion- It is not easy to make money by investing in rare coins Debt Capital Debt capital- borrowed capital. Three types of debt capital- bank loans, Short-term debt securities, and long-term debt securities. Short-term debt security- also, called money market securities or money market instruments. >1 year Long-term debt securities- also, called bonds <1 year
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Debtor-creditor relationship- relationship involving a borrower and a lender. Maturity date- (due date)- day principal must be paid Principal- amount borrowed. Par and Par value used instead of principal Discount- less than par value, and premium (more than par value) Secured- a loan agreement that has borrower give collateral, property that can be taken if he defaults Default- borrower failed to pay interest and/or principal Mortgage- loan secured by real estate.
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