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Money and Banking Chapter 4
Terms in this set (15)
a dollar paid to you one year from now is less valuable than a dollar paid to you today.
Yield to Maturity
the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
lender provides borrower with funds that must be paid back by maturity date with interest payments
Fixed Payment Loan
lender provides borrower with an amount of funds that the borrower must pay back by making the same payment, consisting of principle and interest every period (mortgage payments)
pays the owner of the bond a fixed interest payment every year until the maturity date, and then at maturity date face value of coupon is also repaid
-The price of a coupon bond and the yield to maturity are negatively related.
-When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.
bought at price lower than face value but face value is repaid at maturity date
-no interest payments, only face value is paid off
a bond with no maturity date that does not repay principal but pays fixed coupon payments forever
Rate of Return
-how well someone will do financially by holding a bond or a security over a period of time
-expressed as a percentage increase over the initial investment cost
Rate of Capital Gain
the change in the bond's price relative to the initial purchase price
prices of longer-maturity bonds respond more dramatically to changes in interest rates
prices and returns for long-term bonds are more volatile than those for shorter-term bonds
the risk level associated with an asset's return that results from interest-rate changes
-short-term debt instruments have no interest rate risk
-long-term debt instruments do
yield to maturity=holding period
-The return equals the yield to maturity only if the holding period equals the time to maturity. Otherwise bonds whose terms to maturity are longer than their holding periods are subject to interest-rate risk
-There is no interest-rate risk for any bond whose time to maturity matches the holding period bc the price at the end of the holding period is fixed at face value so already known when you purchase.
a rise in interest rates
is associated with a fall in bond prices, resulting in a capital loss if time to maturity is longer than the holding period.
- if market interest rates rise then people are unhappy with a lower bond interest rate so the bond price has to be lowered so the yield is the same
Nominal interest rate
does not factor in inflation
Real interest rates
-gives a sense of the true cost of borrowing bc is adjusted for changes in price level
- Ex ante real interest rate is adjusted for expected changes in the price level
-ex ante interest rate=nominal interest rate- expected inflation rate
- Ex post real interest rate is adjusted for actual changes in the price level
-Calculated by nominal interest rate minus the inflation rate for a given period.
-when real interest rate is low, greater incentives to borrow and fewer incentives to loan
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