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Lecture #8

# Lecture #8 - Ec 136 Financial Economics Lecture 8 September...

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Ec 136, Financial Economics Lecture 8 September 22

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Outline for today 1. Pricing coupon bonds 2. Geometric sum 3. Bond prices and yields http://econ.berkeley.edu/~szeidl/ec136/ec136index.htm Readings: BKM Chapter 14.1-14.4, 15.1, 16.1 (also 15.2 for editions 7&8) Problem set 3 : due September 24, Thurs, in class.
1. Pricing coupon bonds ° Price of zero-coupon bond w/ maturity T and face value F P = F (1 + R ) T : ° Consider coupon bond which pays \$ C each year and has face value F . { Like package of zero coupon bonds for each coupon payment plus one for face value. ° By the law of one price, P = value today of \$ C in one year +value today of \$ C in two years + ::: + value today of \$ C in T years +value today of \$ F in T years.

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° If T years remain till maturity, the price of the bond is related to its yield by P = C 1 + R + C (1 + R ) 2 + ::: + C (1 + R ) T + F (1 + R ) T = T X t =1 C (1 + R ) t + F (1 + R ) T : ° Note, we are using the same yield R to discount all future payments. ° Claim: T X t =1 C (1 + R ) t = C 1 + R ± 1 ² ° 1 1+ R ± T 1 ² 1 1+ R = C R ± 1 ² ² 1 1 + R ³ T !
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Lecture #8 - Ec 136 Financial Economics Lecture 8 September...

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