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Terms in this set (51)
interest is earned on the original principal
Interest earned on both the principal amount and any interest already earned.
money paid or received later in time; know the present value and need to figure out the future value, also called compounding.
money paid or received earlier in time; the process of finding the present value of some future amount, is also called discounting.
one cash flow
A series of equal payments at fixed intervals for a specified number of periods
an annuity paid in a series of more or less equal payments at the end for a fixed number of periods
An annuity for which the cash flows occur at the beginning of the period for a fixed number of periods
annuity with an infinite life (infinite series of equal payments); can only find present value.
i.e.: preferred stock
Effective annual rate
The interest rate expressed as if it were compounded once per year. The more often it is compounded annually the higher the effective annual rate.
the interest rate paid on debt securities without an adjustment for any loss in purchasing power.
pure discount loan
principal amount is repaid at some future date, without any periodic interest payments; borrower pays a single lump sum (principal + interest) at maturity.
i.e. treasury bill
interest only loan
you borrow an amount today and pay only interest over the life of the loan. The full principal is paid back at the end of the contract.
i.e. corporate bond
borrow an amount of money today and pay back principal and interest in equal installments. Interest is paid on outstanding principal (annuity).
long term debt, issued by a business or government. borrower agrees to make payments of interest and principal on specified dates to bondholders.
par (face) value
principal. value stated on the bond, amount repaid at the end of the loan; usually $1000
coupon (stated) rate
annual rate stated on bond (interest)
interest payment; par value x coupon rate / times per year
date on which par value must be paid to the bondholder
yield to maturity
the required market rate or rate that makes the discounted cash flows from a bond equal to the bond's market price (annual return)
if YTM > coupon rate = fair value < par value
if YTM < coupon rate = fair value > par value
if YTM = coupon rate = fair value = par value
interest rate risk
changes in bond prices due to fluctuating interest rates.
legal written agreement between the debt issuer and the lender detailing the terms of the debt issue
an unsecured debt with 10 or more years to maturity
an unsecured debt with less than 10 years to maturity
issuer required to retire a portion of the bond issued each year
the issuer had the right to buy back (redeem/call back it's bonds before maturity.
the difference between the 2 prices
independent evaluation of the default risk of the issuer's debt.
risk that companies were unable to make required payments on their debt obligation
Fitch, Standard and Poors (S&P), and Moody's
bonds issued by the federal government, the interest income is exempt from state taxation
issued by local/state gov, income is exempt from federal tax
floating rate bonds
coupon payments adjust periodically according to an index
Treasury Inflation Protected Securities (TIPS)
the par value increases with inflation
coupon is paid if income is sufficient (higher required return)
can be converted into stocks at the bondholder's discretion.
bondholders have the right to redeem for par at their discretion (lower required return)
real rate of interest (r)
rate adjusted for inflation
nominal rate - rate not adjusted for inflation
real rate - rate adjusted for inflation
a theoretical relationship between nominal returns, real returns, and the expected inflation rate. (1+R) = (1+r)(1+h)
nominal rate of interest (R) =
real rate of interest (r) =
inflation rate (h) =
interest rate risk
% changes in bond prices due to fluctuating interest rates
the higher the YTM
The lower the bond value
as YTM increases
bond values decrease at a decreasing rate
the higher (lower) the coupon rate
the lower (higher) the interest rate risk exposure
the longer (shorter) the maturity on a bond issue
the larger (smaller) the interest rate risk exposure
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