Notes 9
Finance 5108
Learning Objectives
1. Understand what the different types of interest rates and compounding types
2. Understand the process for measuring rates and how rates are determined for
zero coupon bonds, bond prices, zero treasury rates, forward rates
3. Value forward rate agreements
4. Understand duration and it function
5. Be able to define convexity and understand it use in the bond market
6. Understand the basis of the term structure of interest rates
7. Interest rate futures fundamentals
Interest rates are the cost of borrowing money.
The con be thought of as the
amount of rent fro the use of money.
Rates are specific to the type of market and
are quoted in the terms of that market.
These rates range from mortgages,
deposit rates, money market rate and many more to foreign government and
corporate rates.
Treasury rates
One of the most quoted and used rate world wide are those of obligations of the
U.S. government rate.
These are considered to be the riskfree or default free
rate.
The range from Tbills (sold at a discount and have a maximum initial
maturity of 1 year) to Treasury notes which are coupon note that have a maturity
from greater than one year to 10 years in initial maturity to Tbonds which have
an initial maturity greater than 10 years.
Libor and LIBID
The London Interbank Offered and Bid rate are important world rates.
These are
the interest rate in the Eurodollar markets.
The Euro dollar market is the rate on
Dollar denominated deposits outside of the United States.
The Eurocurrency
markets of which the Eurodollar market is actually a part of are extra government
and unregulated.
Repurchase and reverse repurchase agreement markets
These are agreement to sell fixed income securities with the agreement to
buy
them back at the original price plus interest.
This is considered by the IRS to be
a financing transaction.
Although many are overnight in term there is also an
active term repo market that is quite expansive.
Measuring rates
Rates are quoted in the market in the manner of the individual type of security.
To equate them you need to bring them to the same base.
This is done by
calculating the effective rate which is the annual rate taking in to consideration
the interest on interest from the different compounding periods.
Let us look at an annual rate of 6% quote rate at different compounding periods.
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 Fall '09
 Rader
 Finance, Derivatives, Interest Rates, Compounding, Interest, Interest Rate, Yield Curve, Zerocoupon bond, forward rate agreement

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