Fixed Income Class Notes Chapter 2

Fixed Income Class Notes Chapter 2 - some future date to...

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Fixed Income Class Notes Chapter 2 – 10/27/11 Any complete description of a fixed income instrument (bond) included not only the actual rate, but how often that rate will be compounded. Spot rate – the rate on a “spot loan”, meaning a loan agreement in which a lender gives money to the borrower at tome of agreement. In other words, the spot rate is the rate paid by to a purchaser of a bond as of the date he buys the bond. The spot rate curve illustrates spot rates for all available terms as of a specific date. IN a normal inflationary environment, the curve will rise as the terms extend. It may rise or flatten depending on current expectations for inflation or other factors. Forward rate – the rate of interest on a “forward loan”, specified at time of agreement as opposed to time of actual loan. A forward loan is an agreement to lend money at some future date, such as a rollover at the maturity of an existing loan. Spot rates are applicable from now to some future date , while forward rates are applicable from
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Unformatted text preview: some future date to six months beyond that date. A six month loan zero years forward is actually a six month spot loan. In Figure 2.2, forward rates are higher than spot through most of the terms because they “anticipate” the spot rate of six months forward for each spot rate term. In a deflationary timeframe, the graph of forward rates would be expected to below the spot rates Bond prices can be expressed in terms of spot rates or forward rates. Intuitively, when a bond pays exactly the market rate of interest, an investor will not require a principal re-payment that is greater than his initial investment. Nor will he expect or accept a principal re-payment that is less than his original investment. Investors who extend a maturity from six months to one year earn an above-market return on that forward loan. Small changes in the spot rates of longer maturity zeros can result in large price differences....
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This note was uploaded on 12/15/2011 for the course ECON 101 taught by Professor Mimir during the Spring '11 term at Maryland.

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