Chapter 4

Chapter 4 - Chapter 4-Understanding Interest Rates Present...

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Chapter 4 - Understanding Interest Rates Present Value •A dollar paid to you one year from now is less valuable than a dollar paid to you today •Why? –A dollar deposited today can earn interest and become $1 x (1+i) one year from today. Discounting the Future Simple Present Value Four Types of Credit Market Instruments •Simple Loan •Fixed Payment Loan •Coupon Bond •Discount Bond Yield to Maturity 2 3 Let = .10 In one year $100 X (1+ 0.10) = $110 In two years $110 X (1 + 0.10) = $121 or 100 X (1 + 0.10) In three years $121 X (1 + 0.10) = $133 or 100 X (1 + 0.10) In years $100 X (1 + ) n i n i n PV = today's (present) value CF = future cash flow (payment) = the interest rate CF PV = (1 + ) i i
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•The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today Simple Loan Fixed Payment Loan Coupon Bond 1 PV = amount borrowed = $100 CF = cash flow in one year = $110 = number of years = 1 $110 $100 = (1 + ) (1 + ) $100 = $110
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This note was uploaded on 02/13/2011 for the course ECON 121 taught by Professor Labadie during the Fall '10 term at GWU.

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Chapter 4 - Chapter 4-Understanding Interest Rates Present...

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