Chap005 - Investments Bodie Kane and Marcus CHAPTER 5 CHAPTER 5 Learning About Learning About Return and Risk Return and Risk from the from the

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Unformatted text preview: Investments Bodie, Kane and Marcus CHAPTER 5 CHAPTER 5 Learning About Learning About Return and Risk Return and Risk from the from the Historical Record Historical Record 5-2 Factors Influencing Rates • Supply – Households • Demand – Businesses • Government’s Net Supply and/or Demand – Federal Reserve Actions 5-3 Real and Nominal Rates of Interest • Nominal interest rate – Growth rate of your money • Real interest rate – Growth rate of your purchasing power • If R is the nominal rate and r the real rate and i is the inflation rate: r R i = - 5-4 Equilibrium Real Rate of Interest • Determined by: – Supply – Demand – Government actions – Expected rate of inflation 5-5 Figure 5.1 Determination of the Equilibrium Real Rate of Interest 5-6 Equilibrium Nominal Rate of Interest • As the inflation rate increases, investors will demand higher nominal rates of return • If E ( i ) denotes current expectations of inflation, then we get the Fisher Equation: ( ) R r E i = + 5-7 Taxes and the Real Rate of Interest • Tax liabilities are based on nominal income – Given a tax rate ( t ), nominal interest rate ( R ), after-tax interest rate is R (1- t ) – Real after-tax rate is: (1 ) ( )(1 ) (1 ) R t i r i t i r t it-- = +-- =-- 5-8 Comparing Rates of Return for Different Holding Periods 100 ( ) 1 ( ) f r T P T = - Zero Coupon Bond P(T) price of a Treasury bond with $100 par value and a maturity of T years. 5-9 Example 5.2 Annualized Rates of Return 5-10 Formula for EARs and APRs 1 { } 1 1 ( ) 1 (1 ) T T f EAR r T EAR APR T = -- = + + 5-11 Table 5.1 Annual Percentage Rates (APR) and Effective Annual Rates (EAR)...
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This note was uploaded on 04/19/2011 for the course FINA 513 taught by Professor Chan during the Spring '11 term at Atlantic PR.

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Chap005 - Investments Bodie Kane and Marcus CHAPTER 5 CHAPTER 5 Learning About Learning About Return and Risk Return and Risk from the from the

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