Economics of Global Money Markets Ch 4
What is the price of a coupon bond that has annual coupon payments of 75, par value of 1000, a yield to maturity of 5%, and a maturity of 2 years.
75 x [ ( 1 - (1/1.05^2) ) / .05 ] + (1000 / 1.05^2) = 1046.49
Real Interest rate
Because borrows and lenders care about the purchasing power of the money they pay out and receive, they care about inflation. so we need to adjust the return on the loan, looking not just at the nominal interest rate but at the inflation adjusted interest rate.
the value of a coupon bond varies "Blank" with the value of its yearly coupon payments and "Blank" with the interest rate paid on it.
Directly, inversely
the price of a coupon bond and the yield to maturity are "BLANK" related; that is, as the yield to maturity "BLANK", the price of the bond "BLANK".
Negatively, rises, fall
the most liquid securities traded in the capital market are
US treasury bonds
a promise to make a series of payments on specific dates in the future is called
a bond
the value of a coupon bond falls as the interest rate rises. how does the present value relationship explain why this is so?
a higher interest rate lowers the present value of future payments
Most businesses replace their computers every 2 or 3 years. Assume a computer costs 2,000 and that it fully depreciates in 3 years, at which point it has no resale value and is throw away. a. if the interest rate for financing the equipment is 10%, what is the minimum annual cash flow that a computer must generate to be worth the purchase? b. suppose the computer did not fully depreciate but still has 250 value at the time it was replaced. what is the minimum annual cash flow that a computer must generate to be worth the purchase?
a. the minimum annual cash flow must be at least 804.23. Explanation: MINIMUM ANNUAL CASH FLOW = 2,000/ [(1/1+i) + (1/1+i^2) + (1/1+i^3)] b. the minimum annual cash flow must be at least 728.70. Explanation: MINIMUM ANNUAL CASH FLOW = 2,000 - (250/(1+i^3)) / [(1/1+i) + (1/1+i^2) + (1/1+i^3)]
money can best be described as
anything that is generally accepted as payment for goods and services or in the settlements of debts
financial markets
channel funds directly from lenders to borrowers
a borrower who needs 5k issues a coupon bond for that amount, with an annual coupon rate of 10%, that will mature in 10 years. the yearly coupon payment for this bond would be
coupon rate times the amount borrowed 5000 x .10 = 500
ranking assets from most liquid to least liquid is
currency, savings bonds, house
example of direct or indirect finance; you buy shares of common stock in the secondary market
direct finance
the fisher equation implies that, all else equal, higher expected inflation is
generally associated with higher nominal interest rates
a primary market is a market
in which newly issued claims are sold by savers to borrows
Nominal Interest Rate
is the interest rate expressed in current dollar terms i = r + (symbol for expected inflation, looks like pie) nom interest rate = i r = the real interest rate Pie = expected inflation
IRR = internal rate of return
is the interest rate that equates the Present Value of an investment with its cost
suppose 100 dollars buys less in the year 2013 than in 2000. then we can say that
moneys store of value has decreased
the nominal interest rate is generally "Blank" the real interest rate is generally "Blank".
observed; estimated. the nominal interest rate is generally observed; the real interest rate is generally estimated using the fisher equation.
a discount bond involves
payment by the borrower to the lender of the face value of the loan at maturity.
a corporation acquires new funds only when its securities are sold in the
primary market by an investment bank
a financial market in which previously issued securities can be resold is called a "BLANK" market
secondary market
real world evidence related to the fisher equation is generally
supportive of its claim that higher inflation rates are related to higher nominal interest rates
you own a factory that produces clothing and are wondering whether you should borrow to purchase a new machine that processes textiles. to make your decision, you should set the present value of the revenues generated by the machine equal to
the cost of the machine
Economists define liquidity as
the ease with which an asset can be exchanged for money
on the maturity date of the coupon bond, the bond issuer will pay
the face value of the bond
in which of the following situations would you prefer to be the borrower?
the interest rate is 25% and the expected inflation rate is 50%
adverse selection is a problem associated with equity and debt contracts arising from
the lenders relative lack of information about the borrowers potential returns and risks of his investment activities
what amount should a bond buyer be willing to pay for a coupon bond?
the present value of its payments
your student loan contract states that you will pay 4% interest for the 10 year duration of the loan, over which inflation is expected to be 1%. given this information which of the following is true.
the real interest rate is 3%. the nominal interest rate is 4% from the contract, unadjusted for inflation. if we subtract the 1% expected inflation from the nominal interest rate, we get the real interest rate of 3%. i = r + inflation rate 4 = r + 1 r = 3%
what is a true characteristic of debt and equities
they can both be long-term financial instruments
True or false; lower interest rates mean high bond prices, and higher interest rates mean lower bond prices.
true; bonds promise fixed payments on future dates, the higher the interest rate, the lower their present value. it follows that the value of a bond varies inversely with the interest rate used to calculate the present value of the promised payment.
if the current interest rate increases, what would you expect to happen to bond prices?
you would expect bond prices to fall because bond prices are the sum of the present values of the future payments associated with the bond. the higher the interest rate, the lower the present value of these payments.