O ex suppose investors demand interest rate of 125 of

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o Ex: suppose investors demand interest rate of 1.25% of govt bond. What would be the price of the Canada 1.25s of 2018, paying annual coupons? lOMoARcPSD|7676370
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o 100/ 1,136.16= 0.088 or 8.8% this is sometmes called the bond’s current yield: annual coupon payment divided by current bond prices o A price decline (that is, a capital loss) of $136.16 is guaranteed, so the overall return over the next 3 years must be less than the 8.8% current yield - Bond types o Premium bonds: bonds that sells for more then its face value An investor who buys a bond at a premium face a capital loss over the life of the bond so the current is always less than the current yield o Discount bonds: bonds that sells for less than its face value - We need a measure of return that takes account of both current yield and the change in a bond’s value over its life o Yield to maturity: interest rate for which the present value of the bond’s payments equals the price o ex: 3 year bond, the yield to maturity is the coupon rate, 10% o Ex: 3 year bond for 1136.16, yield of maturity is only 5%. At that discount rate, the bond’s present value equals its actual market value, 1136.16: 6.4 bond rates of return Downloaded by Abdullah Abid ([email protected]) lOMoARcPSD|7676370
- o Rate of return: total income per period per dollar invested - Is there any connecton between yield of maturity and the rate of return during a partcular period? o Yes, if the bond’s yield to maturity remains unchanged during the investment period, its rate of return will equal that yield o Ex: yield on that 5.5% Canada bond stays at 3%; when bond matures in 4 years the value is: Your total proft is $55 + (1092.93 – 1114.49)= 33.44 The return on your investment is therefore 33.44/ 1114.49 = 3% just equal to the yield of maturity - Taxes and rates of returns Downloaded by Abdullah Abid ([email protected]) lOMoARcPSD|7676370
o - Multperiod rates of return o 6.5 the yield curve o Note that the longer the maturity, the slightly higher the yield. Sometmes long term bonds ofer lower yields o Yield curves or term structure of interest rates: graph of the relatonship between tme to maturity and yield to maturity, for bonds that difer only in their maturity dates To properly assess the relatonship between yields and years to maturity, it must be based on yields to maturity of bonds with the same coupon rate and same risk but diferent maturites Downloaded by Abdullah Abid ([email protected]) lOMoARcPSD|7676370
- Nominal and real interest rates o The real

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