Class 12 Before

H for a zero coupon government bond yield curve there

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H For a zero-coupon government bond yield curve, there are three components:

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Upward-Sloping Yield Curve 15
Downward-Sloping Yield Curve 16

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17 The Yield Curve and Discount Rates H The term structure can be used to compute the present and future values of a risk-free cash flow over different investment horizons. H Present value of one cash flow: H Present value of a cash flow stream using the Term Structure of Interest Rates:
18 The Term Structure and our Annuity Formula H If the term structure is not flat, can we still use our annuity formula? H Consider our previous example: H Then if we can find an interest rate r for which the following holds, we can still use our annuity formula. H By the way: Such an r , that is the interest rate that sets the present value of a series of cash flows equal to its price is called the Internal Rate of Return (IRR)

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19 Reviving our Annuity Formula H Using a spreadsheet or a financial calculator, the IRR for below equation is equal to . H This means that for r = , we can price the annuity of cash flows using our annuity formula: H Note that the IRR always lies between the lowest and the highest discount rate in the term structure used to initially calculate the PV of the annuity.
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