Chap003

# Chap003 - Chapter 03 Interest Rates and Security Valuation...

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Chapter 03 - Interest Rates and Security Valuation 3-1 Chapter Three Interest Rates and Security Valuation I. Chapter Outline 1. Interest Rates as a Determinant of Financial Security Values: Chapter Overview 2. Various Interest Rate Measures a. Coupon Rate b. Required Rate of Return c. Expected Rate of Return d. Required Versus Expected Rates of Return: The Role of Efficient Markets e. Realized Rate of Return 3. Bond Valuation a. Formula Used to Calculate Fair Present Values b. Formula Used to Calculate Yield to Maturity c. Equity Valuation Models 4. Impact of Interest Rate Changes on Security Values 5. Impact of Maturity on Security Values a. Maturity and Security Prices b. Maturity and Security Price Sensitivity to Changes in Interest Rates 6. Impact of Coupon Rates on Security Values a. Coupon Rate and Security Price b. Coupon Rate and Security Price Sensitivity to Changes in Interest Rates 7. Duration a. A Simple Illustration for Duration b. A General Formula for Duration c. Features of Duration d. Economic Meaning of Duration e. Large Interest Rate Changes and Duration Appendix 3A: Duration and Immunization Appendix 3B: More on Convexity (Appendices are available only at www.mhhe.com/sc4e )

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Chapter 03 - Interest Rates and Security Valuation 3-2 II. Chapter in Perspective This is the second chapter that is designed to familiarize the students with the determinants of fixed income valuation. This chapter has seven closely related sections which focus primarily on bond pricing and the bond price formula. From the first three sections of the chapter readers should learn how to calculate a bond‟s price, the difference between the required rate of return, the expected rate of return and the realized return and how to calculate each. Efficient markets are briefly introduced by relating the expected and required rates of return and by comparing market prices to calculated fair present values. Section 4 introduces bond price volatility and illustrates how changing interest rates can affect FIs. Sections 5 and 6 discuss the effects of maturity and coupon on bond price volatility. Section 7 introduces the concept of duration and illustrates how to calculate Macauley duration. Appendix 3A provides an example of immunization using duration and Appendix 3B explains more about the concept of convexity and demonstrates the effect of convexity on bond price predictions. III. Key Concepts and Definitions to Communicate to Students Required rate of return Price sensitivity Expected rate of return Maturity and price sensitivity Realized rate of return Coupon and price sensitivity Coupon rate Duration Market efficiency Elasticity Zero coupon bonds Modified duration Par, premium and discount bonds Convexity Yield to maturity Fair present value IV. Teaching Notes 1. Interest Rates as a Determinant of Financial Security Values: Chapter Overview This chapter applies the time value of money concepts developed in Chapter 2 to explain bond pricing and rates. The determinants of bond price volatility, duration and convexity
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Chap003 - Chapter 03 Interest Rates and Security Valuation...

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