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FIN 384 Chapter 5 Terms
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Chap 5 Vocabulary
Terms in this set (30)
Time Value of Money
A dollar today is worth more than a dollar received at some future date.
Present Value
The value today of a future stream of cash payments discounted at the appropriate discount rate.
Future Value
The worth in the future of a currently held amount of money if it is invested and reinvested at known interest rates.
Compounding
The calculation of future value based on the assumption that all interest earned will be reinvested to earn additional interest.
Discounting
The calculation for finding the present value of some future sum of money.
Opportunity Cost
The interest rate on the next best alternative investment.
Bond
A contractual obligation of a borrower to make periodic cash payments to a lender over a given number of years.
Bond Issuer
The borrower of a bond contract. (The one who makes periodic cash payments to the lender)
Bondholder
The lender in a bond contract.
Par Value (Principal, Face Value)
The stated or face value of a stock or bond. For debt instruments, the par value is usually the final principal payment.
Coupon Payment
The periodic interest payment in a bond contract.
Coupon Rate
The amount of coupon payments received in a year stated as a percentage of the face value.
Term-to-Maturity
The length of time until the final payment of a debt security.
Discount Bond
A bond that sells below its par or face value. A bond sells at a discount when the market rate of interest is above the bond's fixed coupon rate.
Par Bond
A bond that is selling at its par value.
Premium Bond
A bond whose market price is above its par or face value. A bond sells at a premium when the market rate of interest is below the bond's fixed coupon rate.
Zero Coupon Bond
Bonds that have no coupon payment but promise a single payment at maturity.
Credit Risk (Default Risk)
The possibility that the borrower will not pay back all or part of the interest or principal as promised.
Reinvestment Risk
The risk resulting from market interest rate changes that cause a bond investor to have to reinvest coupon payments at interest rates different from the bond's promised yield.
Price Risk
Interest rate changes can cause the market price of a bond to rise or fall, resulting in gains or losses for an investor.
Yield-to-Maturity (Promised Yield)
The discount rate that equates the present value of all cash flows from a bond (interest payments plus principal) to the market price of the bond.
Expected Yield
The expected return on a bond at the end of a relevant holding period based on predictions made from interest rate forecasts.
Realized Yield
The rate of return earned on a bond given the price paid and the cash flows actually received by the investor.
Total Return
The return to a bond investor that reflects coupon payments, capital gains or losses, and potential changes in the interest rate at which coupon payments are reinvested.
Bond Price Volatility
The percentage change in bond price for a given change in yield.
Interest Rate Risk
The risk that changes in interest rates will cause an asset's price and realized yield to differ from the purchase price and initially anticipated yield.
Duration
A measure of interest rate risk (or bond price volatility) that considers both coupon rate and maturity; it is the weighted average of the number of years until the present value of each of the bond's cash flows is received.
Convexity
The curve representing T-bonds' price/yield relationship is convex. Thus, convexity is the adjustment for the shape of the curve in the formula for estimating the percentage change in the price of the bond corresponding to a given change in the market interest rate.
Treasury Bill (T-Bill)
Direct obligation of the federal government with initial maturities ranging from 3 months to 1 year. They are considered to have no default risk and are the most marketable of any security issued.
Treasury Notes and Bonds
Similar to Treasury bills in that they are issued by the Treasury and are considered free of default risk; they differ from bills in that they are coupon issues, redeemable at face value upon maturity.
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