FINA 4110 Slides 4 [Interest Rates]

# FINA 4110 Slides 4 [Interest Rates] - Interest Rates...

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Interest Rates Chapter 4 1

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Types of Rates z Treasury rates z LIBOR rates z Repo rates 2
Measuring Interest Rates z The compounding frequency used for an interest rate is the unit of measurement z The difference between quarterly and annual compounding is analogous to the difference between miles and kilometers 3

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Continuous Compounding (Page 83) z In the limit as we compound more and more frequently we obtain continuously compounded interest rates z \$100 grows to \$ 100e RT when invested at a continuously compounded rate R for time T z \$100 received at time T discounts to \$ 100e - RT at time zero when the continuously compounded discount rate is R 4
Conversion Formulas (Page 83) Define R c : continuously compounded rate R m : same rate with compounding m times per year () 1 1 ln / = + = m R m m c c e m R m R m R 5

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Zero Rates A zero rate (or spot rate), for maturity T is the rate of interest earned on an investment that provides a payoff only at time T 6
Example (Table 4.2, page 85) Maturity (years) Zero Rate (% cont. comp.) 0.5 5.0 1.0 5.8 1.5 6.4 2.0 6.8 7

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Bond Pricing z To calculate the cash price of a bond we discount each cash flow at the appropriate zero rate z In our example, the theoretical price of a two- year bond providing a 6% coupon semiannually is 39 . 98 103 3 3 3 0 . 2 068 . 0
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## This note was uploaded on 03/03/2012 for the course FINA 4110 taught by Professor Liu during the Spring '11 term at CUHK.

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FINA 4110 Slides 4 [Interest Rates] - Interest Rates...

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