CH 6 - Chapter 6 I. II. III. Introduction a. Car loans,...

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Chapter 6 I. Introduction a. Car loans, home mortgages and even credit card balances all create a loan from a financial intermediary- just like government and corporate bonds b. Virtually any financial arrangement involving the current transfer of resources from a lender to a borrower, with a transfer back in the future is a form of a bond c. This free flow of resources through bond markets is essential to a well functioning economy. d. Alexander Hamilton, the first Secretary of the US Treasury, brought bonds to the US i. One of his first acts was to consolidate all debt from the Revolutionary War resulting in the first US government bonds e. Many features of original bonds is the same, even with a more complex bond market II. Bond Prices a. A standard bond specifies the fixed amounts to be paid and the exact dates of the payments i. How much should you be willing to pay for a bond? b. That depends of the bond characteristics c. We will examine four basic types. 1. Zero- coupon or discount bond a. Promise a single payment on a future date b. Treasury bill 2. Fixed- payment loan a. Sequenced of fixed payments b. Mortgage or car loan 3. Coupon bond a. Periodic interest payments + principle repayment at maturity b. US Treasury Bonds and most corporate bonds 4. Consol a. Periodic interest payments forever, principal never repaid b. UK government has some outstanding III. Zero-Coupon Bonds a. US Treasury Bills (T- Bills) are the most straight forward type of bond i. Each T-Bill represents a promise by the US government to pay $100 on a fixed future date ii. No coupon payments: zero-coupon bonds iii. Also called pure discount bonds (or discount bonds) since the price is less than face value- they sell at a discount b. Price of $100 face value zero-coupon bond= $100/ (1+ i ) n c. Assume i= 5% i. Price of a One-Year Treasury Bill 1. =100/(1+.05)= $95.24 d. For a zero-coupon bond, the relationship between the price and the interest rate is the same as we saw on present value calculations e. When the price moves, the interest rate moces with it, in the opppoiste direction
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Chapter 6 f. We can compute the interest rate from the price using the present value formula IV. Fixed Payment Loans a. Home mortgates and car loans are fixed payment loans i. They promise a fixed number of equal payments at regular intercals ii. Amortized loans- the borrower pays off part of the principlal along with the interest for the life of the loan. b. Value of a Fixed Payment Loan Fixed payment/(1+i)+ Fixed Payment/ (1+i) 2 … Fixed Payment/ (1+i)n= c. The sum of the present value of the payments V. Coupon Bonds a. The issuer of a coupon bond promises to make a series of periodic interest payments (coupon payments), plus a principal payment at maturity b. Price of Coupon Bond i. P CB =[Coupon Payment/ (1+ i )+ Coupon Payment/ (1+
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This note was uploaded on 03/02/2011 for the course ECON 121 taught by Professor Labadie during the Spring '10 term at GWU.

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CH 6 - Chapter 6 I. II. III. Introduction a. Car loans,...

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