Lecture 3_YIELDS - Lecture3 MeasuringYield L3XiaodingLiu...

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Lecture 3 Measuring Yield L3 Xiaoding Liu 1 FIN4243 Fall2009
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Topics Understand how to calculate the yield  (IRR) on any investment Understand and calculate different yield  measures Understand potential sources of a bond’s  dollar return Understand how to calculate bond’s total  return L3 Xiaoding Liu FIN4243 Fall2009 2
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Computing Yield or IRR The yield on any investment is the interest rate  that will make the present value of the cash  flows from the investment equal to the price of  the investment  Or mathematically, the yield on any investment,  y , is the interest rate that satisfies       or where CF t =cash flow in period t, P=price of the  investment, N=number of periods L3 Xiaoding Liu FIN4243 Fall2009 3
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Computing Yield or IRR The yield is also called the internal rate of  return The yield computed is the yield for the  period If the cash flow is semiannual, the yield is  semiannual yield If the cash flow is monthly, the yield is  monthly yield Computation needs financial calculator,  computer software or trial and error L3 Xiaoding Liu FIN4243 Fall2009 4
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Special Case When there is only one future cash flow,  we can solve for the yield L3 Xiaoding Liu FIN4243 Fall2009 5
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Annualizing Yields i: periodic interest rate, ex. semiannually,  monthly m: frequency of payments per year, ex.2, 12  Simple annual interest rate = i x m Periodic interest rate i = simple annual interest  rate/m Effective annual yield = (1+i) m  – 1 Periodic interest rate i = (1+effective annual  yield) 1/m -1 L3 Xiaoding Liu FIN4243 Fall2009 6
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Example 1 Given monthly interest rate i=2% Simple annual interest rate = 2%x12=24% Effective annual yield = (1+0.02) 12  – 1=26.8% Given simple annual interest rate of 18% Quarterly interest rate = 18%/4=4.5% Given effective annual yield of 18% Quarterly interest rate = (1+0.18) 1/4 -1=4.2% L3 Xiaoding Liu FIN4243 Fall2009 7
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Conventional Yield Measures Bond yield measures commonly quoted by  dealers and used by portfolio managers 1. Current Yield 2. Yield to Maturity 3. Yield to Call 4. Yield to Put 5. Yield to Worst 6. Cash Flow Yield 7. Yield (IRR) for a portfolio L3 Xiaoding Liu FIN4243 Fall2009 8
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Conventional Yield Measures 1. Current Yield CY = Annual dollar coupon interest/price
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Lecture 3_YIELDS - Lecture3 MeasuringYield L3XiaodingLiu...

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