Chapter4UnderstandingInterestRates©2013PearsonEducation,Inc.Allrightsreserved.4-2MeasuringInterestRates•PresentValue:•Adollarpaidtoyouoneyearfromnowislessvaluablethanadollarpaidtoyoutoday•Why?–Adollardepositedtodaycanearninterestandbecome$1x(1+i)oneyearfromtoday.©2013PearsonEducation,Inc.Allrightsreserved.4-3DiscountingtheFuture23Let=.10Inoneyear$100X(1+0.10)=$110Intwoyears$110X(1+0.10)=$121or100X(1+0.10)Inthreeyears$121X(1+0.10)=$133or100X(1+0.10)Inyears$100X(1+)nini©2013PearsonEducation,Inc.Allrightsreserved.4-4SimplePresentValuenPV=today's(present)valueCF=futurecashflow(payment)=theinterestrateCFPV=(1+)ii©2013PearsonEducation,Inc.Allrightsreserved.4-5TimeLine$100$100Year01PV1002$100$100n100/(1+i)100/(1+i)2100/(1+i)n•Cannotdirectlycomparepaymentsscheduledindifferentpointsinthetimeline©2013PearsonEducation,Inc.Allrightsreserved.4-6FourTypesofCreditMarketInstruments•SimpleLoan•FixedPaymentLoan•CouponBond•DiscountBond©2013PearsonEducation,Inc.Allrightsreserved.4-7YieldtoMaturity•Theinterestratethatequatesthepresentvalueofcashflowpaymentsreceivedfromadebtinstrumentwithitsvaluetoday©2013PearsonEducation,Inc.Allrightsreserved.4-8SimpleLoan1PV=amountborrowed=$100CF=cashflowinoneyear=$110=numberofyears=1$110$100=(1+)(1+)$100=$110$110(1+)=$100=0.10=10%Forsimpleloans,thesimpleinterestrateequniiiialstheyieldtomaturity©2013PearsonEducation,Inc.Allrightsreserved.4-9FixedPaymentLoan23ThesamecashflowpaymenteveryperiodthroughoutthelifeoftheloanLV=loanvalueFP=fixedyearlypayment=numberofyearsuntilmaturityFPFPFPFPLV=...+1+(1+)(1+)(1+)nniiii©2013PearsonEducation,Inc.Allrightsreserved.4-10CouponBond23Usingthesamestrategyusedforthefixed-paymentloan:P=priceofcouponbondC=yearlycouponpaymentF=facevalueofthebond=yearstomaturitydateCCCCFP=...+1+(1+)(1+)(1+)(1nniiii+)ni©2013PearsonEducation,Inc.Allrightsreserved.4-11Table1YieldstoMaturityona10%-Coupon-RateBondMaturinginTenYears(FaceValue=$1,000)•Whenthecouponbondispricedatitsfacevalue,theyieldtomaturitye...
