finance exam 2
differences betw APR and EAR
APR is based on simple interest, EAR takes compound interest APR is most useful for evaluating mortgage and auto loans, while EAR (or APY) is most effective for evaluating frequently compounding loans such as credit cards.
what is APR
Annual Percentage Rate most common rate
The Fisher Effect involves?
Nominal rate, the real rate, and inflation
Nominnal
The nominal risk-free rate is the rate of interest earned on arisk-free investment such as a bank CD or a treasury security.• It is essentially a compensation paid for the giving up of consumption by the investor
real interest
The real rate of interest adjusts for the erosion of purchasingpower caused by inflation.
When interest rates are stated or given for loan repayments, it is assumed that they are ________ unless specifically stated otherwise.
annual percentage rates
yield curve
be able to do probs
The ________ compensates the investor for the additional risk that the loan will not be repaid in full.
default premium
what is EAR/APY? know how to find
effective annual rate is the true return to the lender and the truse cost of the borrowing to the borrower AKA APY
In constructing a yield curve you place interest rates on the vertical axis, and risk on the horizontal axis.
false
bond ratings
is a grade given to a bond that indicates their credit quality
fisher equation
is the relationship between the real rate (r*) and the nominal interest rate (r) equation: 𝑟∗ + ℎ
Bond pricing
is the value of future cash stream generated by a bond
what is a bond?
issued by government and corportions when they want to raise money
zero coupon bond pricing
know as pure discount bonds and sold at discount from face value no payment of interest over the life of bond
To determine the interest paid each compounding period, we take the advertised annual percentage rate and simply divide it by the ________ to get the appropriate periodic interest rate.
number of compounding periods per year
key components of a bond
par value, coupon, coupon rate, maturity date, yield to maturity
annual and periodic interest rates
periodic is the annual interest rate divided by the # of compounding periods
inflation
rise in prices which is a delcine in purchasing power
The most common shape for a yield curve is upward sloping.
true
what is YTM?
yield to maturity is the total anticipated on a bond if the bond is held until it matures
Assume that you are willing to postpone consumption today and buy a certificate of deposit (CD) at your local bank. Your reward for postponing consumption implies that at the end of the year ________.
you will be able to buy more goods or services