Unformatted text preview: PHALL82241 PINDYCK CHAPTER 15 page 6 of 10 FIGURE 15.1 Present Value of the Cash Flow from a Bond PDV of 2.0
cash flow 1.9
(thousands
of dollars) 1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
0 0.05 0.10 0.15 0.20
Interest rate Because most of the bond’s payments occur in the future, the present discounted
value declines as the interest rate increases. For example, if the interest rate is
5 percent, the PDV of a 10year bond paying $100 per year on a principal of $1000 is
$1386. At an interest rate of 15 percent, the PDV is $749. Fig 1501.eps PHALL82241 PINDYCK CHAPTER 15 page 7 of 10 FIGURE 15.2 Effective Yield on a Bond PDV of
payments
(value of
bond)
(thousands
of dollars) 2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0 0.05 0.10 0.15 0.20
Interest rate The effective yield is the interest rate that equates the present value of the bond’s
payment stream with the bond’s market price. The figure shows the present value of
the payment stream as a function of the interest rate. The effective yield is found by
drawing a horizontal line at the level of the bond’s price. For example, if the price
of this bond were $1000, its effective yield would be 10 percent. If the price were
$1300, the effective yield would be about 6 percent; if the price were $700, it would be
16.2 percent. Fig 1502.eps PHALL82241 PINDYCK CHAPTER 15 page 8 of 10 FIGURE 15.3 Net Present Value of a Factory Net
present
value
(millions
of dollars) 10
9
8
7
6
5
4
3
2
1
0
–1
–2
–3
–4
–5
–6
0 0.05 R* 0.10 0.15 0.20
Discount rate, R The NPV of a factory is the present discounted value of all the cash flows involved in
building and operating it. Here it is the PDV of the flow of future profits less the current
cost of construction. The NPV declines as the discount rate increases. At discount
rate R*, the NPV is zero. Fig 1503.eps PHALL82241 PINDYCK CHAPTER 15 page 9 of 10 FIGURE 15.4 Price of an Exhaustible Resource Price Price PT PT Demand
P0 P0 P–c c c Marginal Extraction
Cost
T (a) Q0 Time Quantity (b) In (a), the price is shown rising over time. Units of a resource in the ground must earn a return commensurate
with that on other assets. Therefore, in a competitive market, price less marginal production cost will rise at the
rate of interest. Part (b) shows the movement up the demand curve as price rises. Fig 1504.eps PHALL82241 PINDYCK CHAPTER 15 page 10 of 10 FIGURE 15.5 Supply and Demand for Loanable Funds R
Interest
rate S R* DF DT DH
Q* Quantity of
loanable funds Market interest rates are determined by the demand and supply of loanable funds.
Households supply funds in order to consume more in the future; the higher the interest
rate, the more they supply. Households and firms both demand funds, but the
higher the interest rate, the less they demand. Shifts in demand or supply cause
changes in interest rates. Fig 1505.eps ...
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This note was uploaded on 09/28/2011 for the course ECON 105 taught by Professor Prof.eco during the Spring '11 term at Indian School of Business.
 Spring '11
 Prof.Eco

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