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20 download_doc-4.php - BUS-G 345 I Measuring interest...

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BUS-G 345 Chapter 4 I. Measuring interest rates a. Intro i. Cash flows 1. Streams of cash payments to the holder ii. Different debt instruments have different cash flows 1. Need to understand present value to compare the value of one kind of debt instrument to another b. Present value i. AKA present discount value ii. A dollar paid to you one year from now is less valuable to you than a dollar paid to you today iii. Because you can deposit a dollar today and earn interest in a savings account iv. Simple interest rate 1. i = (additional payment)/(principal) v. PV = [future cash flow (CF)]/[(1+i) n ] vi. Allows us to figure out today’s value (price) of a credit (debt) market instrument at a given simple interest rate i by just adding up the individual present values of all the future payments received 1. Allows us to compare the values of two or more instruments with very different payment schedules c. 4 types of Credit market instruments i. Simple loan 1. Lender provides the borrower with an amount of funds (the principal) that must be repaid to the lender at the maturity date plus an additional payment for the interest 2. Example: commercial loans to businesses ii. Fixed-payment loan
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BUS-G 345 Chapter 4 1. AKA fully amortized loan 2. The lender provides the borrower with an amount of funds, which must be repaid by making the same payment every period, consisting of part of the principal + part interest for a set number of years 3. Examples: auto loans and mortgages iii. Coupon bond 1. Pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturity date, when a specified final amount (face value/par value) is repaid 2.
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