Principles of Macroeconomics (9th Edition)

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CHAPTER 5: VALUATION OF BONDS A. OVERVIEW Motivation: What are bonds? Definitions: Bond – security that obligates the issuer to make specified payments to the bondholder(s). Face value / par value / maturity value – payment at the maturity of the bond. Coupon rate – annual interest payment as a % of face value. Coupon – interest payments paid to bondholder(s). Yield – (of a debt instrument) is the annualized percentage increase in the value of the investment (return) Yield to maturity – annual rate of interest earned on a security purchased on a given day and held to maturity Term structure – length of time that the debt instrument matures Term structure of interest rates (TSIR) - the relationship between the interest rate (rate of return) and the time to maturity for similar-risk debt securities Yield curve – graphical presentation of the term structure of interest rates Normal yield curve: upward sloping Cost of short-term borrowing is cheaper than long-term borrowing Inverted yield curve: downward sloping Cost of long-term borrowing is cheaper than short-term borrowing Flat yield curve: similar borrowing costs for both long- and short-term loans Example . Government raised money by selling a 10-year Government of Canada bonds. Each bond has a face value of $1,000. Coupon rate is 7.25%. B. BOND PRICES AND YIELDS
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