Chapter+4++Understanding+Interest+Rates (2)

# Chapter+4++Understanding+Interest+Rates (2) - Chapter 4...

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Chapter 4 Understanding Interest Rates - Measuring Interest Rates Present value (PV) and Future value (FV) (cash flow (CF) in the future) Four types of credit market instruments 1. A simple loan. 2. A fixed-payment plan. 3. A coupon bond. 4. A discount bond Perpetuity (consol) - Yield on a Discount Basis - The Distinction between Interest Rates and Returns Interest-rate Risk - The Distinction between Real and Nominal Interest Rates Fisher equation Measuring Interest Rates A concept known as the yield to maturity is the most accurate measure of interest rates; the yield to maturity is what economists mean when they use the term interest rate. Definition 1 Present Value (PV) : MEASURING THE TIME VALUE OF MONEY. Present value refers to the amount of money today that would be needed to produce, using prevailing interest rates, a given future amount of money. Definition 2 Future Value (FV, or CF (cash flow in 8 th edition)) : The amount of money in the future that an amount of money today will yield, given prevailing interest rates, is called the future value. Ex. if you made your friend, Jane, a simple loan of \$100 for one year, you would require her to repay the principal of \$100 in one year’s time along with an additional payment for interest; say, \$10. At the end of first year, you will have At the end of second year, you will have At the end of third year, you will have Generalizing, at the end of n years 1

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Discounting the future : \$133 three years from now under 10% interest rate is worth
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Chapter+4++Understanding+Interest+Rates (2) - Chapter 4...

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