C.4 The Meaning of Interest Rates

Question 1

Cash flows

Answer 1

Cash payments to the holder of a security

Question 2

Present value a.k.a.

Answer 2

Present discounted value

Question 3

Simple loan

Answer 3

Debt repaid to lender at maturity date with a payment of interest

Question 4

Four types of Credit Market Instruments

Answer 4

1. Simple loan
2. Fixed-payment loan
3. Coupon bond
4. Discount bond

Question 5

Fixed-payment loan (def and a.k.a.)

Answer 5

Repay loan at a fixed payment periodically for a set number of time.
A.k.a. Fully amortized loan

Question 6

Coupon bond

Answer 6

Pays the owner fixed-interest payment every year until the maturity date when a specified final amount is repaid

Question 7

What is the final amount paid on a coupon bond known as

Answer 7

Face value or par value

Question 8

What pieces of information identify a coupon bond

Answer 8

1. FV
2. Corp or govt that issued the bond
3. Maturity date
4. Coupon rate

Question 9

Coupon rate

Answer 9

Dollar amount of the yearly coupon payment expressed as a % of the FV of the bond

Question 10

Discount bond

Answer 10

Bought at a price below its FV and whose FV is repaid at the maturity date. No interest payments

Question 11

Discount bond a.k.a.

Answer 11

Zero-coupon bond

Question 12

Yield to maturity

Answer 12

The interest rate that equates the PV of cash flow payments received from a debt instruments with its value today

Question 13

Yield to maturity of a simple loan

Answer 13

Simple interest rate

Question 14

When a coupon bond is priced at its FV, the YTM equals

Answer 14

The coupon rate

Question 15

The price of a coupon bond and YTM are ______ related

Answer 15

Negatively

Question 16

The YTM is _____ than the coupon rate when the bond price is below its FV

Answer 16

Greater

Question 17

Consol (def and a.k.a.)

Answer 17

A perpetual bond with no maturity date and no repayment of principal that periodically makes fixed coupon payments.
A.k.a. a perpetuity

Question 18

How to calculate price of consol

Answer 18

P_c = C/i_c
where,
P_c = price of the perpetuity
C = yearly payment 
i_c = YTM of perpetuity

Question 19

Current yield

Answer 19

An approximation of the YTM that equals the yearly coupon payment divided by the price of a coupon bond

Question 20

Rate of return

Answer 20

The payments to the owner of a security plus the change in the security’s value, expressed as a fraction of its purchase price.

Question 21

Eq’n for return on a bond held from time t to time t+1

Answer 21

R = (C + P_t+1 - P_t)/P_t
where,
C = coupon pmt

Question 22

Rate of capital gain

Answer 22

The change in a security’s price relative to the initial purchase price

Question 23

Eq’n for rate of capital gain. How can you rewrite R (return) from this?

Answer 23

g = (P_t+1 - P_t)/P_t
R = i_c + g
where,
i_c = C/P_t

Question 24

What happens when there’s a rise in the interest rate and the term to maturity is longer than their holding periods

Answer 24

Capital losses

Question 25

The more distant a bond's maturity rate, the _____ the size of the % price change associated with an interest rate change

Answer 25

Greater

Question 26

The more distant a bond's maturity rate, the _____ the rate of return that occurs as a result of an increase in the interest rate

Answer 26

Lower

Question 27

Prices and returns for long-term bonds are more _______ than those for shorter-term bonds

Answer 27

Volatile

Question 28

Interest-rate risk

Answer 28

The possible reduction in returns associated with changes in interest rates

Question 29

There is no interest rate risk for any bond whose...

Answer 29

time to maturity matches the holding period

Question 30

Real interest rate is a.k.a.

Answer 30

ex ante real interest rate

Question 31

Fisher eq'n

Answer 31

``` i = r + pi^e where, i = nominal r = real interest rate pi^e = expected inflation ```

Question 32

When the real interest is low, there are ______ incentives to borrow and _____ incentives to lend

Answer 32

greater; fewer