FIN MKTS:
Chapter 3
I.
Measuring Interest Rates
a.
Present Value
: dollar of cash paid to you one year from now is less valuable than a dollar paid today.
i.
Simple Loan: principal + interest payment; interest rate = int. pmt/amt. of loan
ii.
Discounting the future: process of calculating today’s value of dollars received in the future
iii.
PV= CF/ (1+i)
n
iv.
*PV is important because it allows us to figure out today’s value of a credit market instrument at
a given simple interest rate (i) by adding up the PV of all the future CFs received
b.
4 Types of Credit Market Instruments
:
timing of cash flows
i.
Simple Loan – money market instruments; commercial loans to businesses
1.
*paid at maturity
ii.
Fixed Payment Loan (full amortized loan) – borrowed funds repaid by making the same payment
every period consisting of part principal and interest for a set number of years; mortgage
1.
* interest payments
iii.
Coupon Bond – pays bond owner a fixed interest payment (coupon payment) every year until the
maturity date when a specified final amount is repaid (face/par value)
1.
*interest payments
iv.
Discount Bond (zerocoupon) – bought at price that is below face value and face value is repaid
at the maturity date; no interest payments
1.
*paid at maturity
c.
Yield to Maturity
: interest rate that equates the present value of cash flows received from a debt
instrument with its value today (*most accurate measure of interest rates)
i.
Simple Loan: *
simple interest rate (int. pmt./amt of loan) = YTM;
i=YTM
ii.
FixedPayment Loan: sum of the present value of all cash flows;
YTM=i
1.
LV=(FP/(1+i)) + (FP/(1+i)
2
) + (FP/(1+i)
3
)… (*calc: n/PV/FV/i)
iii.
Coupon Bond: sum of the PV of all coupon payments plus the PV of the final payment of the
face value of the bond
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 Spring '08
 DUONG
 Interest Rates, Interest, Interest Rate, rate risk

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