Chapter 4: The Meaning of Interest Rates

Coupon Rate

The dollar amount of the yearly coupon payment expressed as a percentage of the face value of a coupon bond.

Nominal Interest Rate

An interest rate that does not take inflation into account.

Coupon Bond

A credit market instrument that pays the owner a fixed interest payment every year until the maturity date, at which time a specified final amount is repaid.

Simple Loan

A credit market instrument that provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment (interest).

Face Value or Par Value

A specified or final amount paid to the owner of a coupon bond at the maturity date.

Fixed-Payment Loan

AKA Fully Amortized Loan A credit market instrument that provides the borrower with an amount of money that is repaid through fixed periodic (usually monthly) payments made over a set number of years.

Consol

AKA Perpetuity A perpetual bond with no maturity date and no repayment of principal, and that makes periodic, fixed coupon payments.

Present Value

AKA Present Discounted Value Today's value of a payment to be received in the future, when the interest rate is i. Also called present discounted value.

Return

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

Discount Bond

AKA Zero-Coupon Bond A credit market instrument that is bought at a price below its face value and whose face value is repaid at the maturity date; it does not make any interest payments.

Current Yield

An approximation of the yield to maturity; equal to the yearly coupon payment divided by the price of a coupon bond.

Cash Flows

Cash payments to the holder of a security.

Rate of Capital Gain

The change in a security's price relative to its initial purchase price.

Real Interest Rate

The interest rate adjusted for expected changes in the price level (inflation) so that it more accurately reflects the true cost of borrowing.

Yield to Maturity

The interest rate that equates the present value of payments received from a credit market instrument with its value today.

Interest Rate Risk

The possible reduction in returns associated with changes in interest rates.