CH3

1 cash flows
2 present value

37
37

3 simple loan

37

4 coupon bond

39

5 coupon rate
6 face value
7 fixed-payment loan

39
39
39

8 discount bond

40

9 yield to maturity

40

10 perpetuity

44

11 current yield

46

12 nominal interest rate

13 real interest rate

48
48

14 real terms
15 indexed bond
16 return

48
50
50

17 rate of capital gain

18 interest-rate risk
19 reinvestment risks

52
54
54

20 duration

56

streams of cash payment to holder of different debt instruments with different timing

present discounted value; based on the commonsense notion that a peso of cash flow TODAY is more va
than the peso to be paid in the future; assumes that the cash today can earn interest on investme
simplest kind of debt instrument; lender provides the borrower with an amount of funds (princip
must be repaid at maturity date, along with additional payment for the interest
pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturi
when a specified final amount (face value or par value)
peso amount of yearly coupon payments expressed as % of the face value of the bond
par value; specified final amount to be repaid on a credit market instrument
fully-amortized loan; credit market instrument in which the lender provides the borrower with an am
funds, which must be repaid by making the same payment every period (i.e. a month), consisting
of the principal and interest for a set number of years. Installment loans e.g. as auto loa
mortgages
zero-coupon bond; bought at a price below its face value (at a discount), and the face value is repai
maturity date. Unlike a coupon bond, a discount bond does not make any interest payments; it ju
off the face value
of the several common ways of calculating interest rates, the most important; the interest ra
equates the present value of cash flows received from a debt instrument with its value today; fi
economists consider it the most accurate measure of interest rates
consol; special case of a coupon bond, a perpetual bond with no maturity date and no repaym
principal
the yearly coupon payment divided by the price of the security

When a coupon bond has a long term to maturity (say, 20 years or more), it is very much
perpetuity, which pays coupon payments forever. This is because the cash flows more than 20 y
the future have such small present discounted values that the value of a long-term coupon bond
close to the value of a perpetuity with the same coupon rate

the interest rate makes no allowance for inflation

the interest rate that is adjusted by subtracting expected changes in the price level (inflation) so
more accurately reflects the true cost of borrowing. This interest rate is more precisely referred to
ex ante real interest rate because it is adjusted for expected changes in the price level.
the interest rate you expect to earn in terms of real goods and services
bonds whose interest and principal payments are adjusted for changes in the price level
rate of return; the payments to the owner plus the change in its value, expressed as a fractio
purchase price
the change in the bonds price relative to the initial purchase price
the riskiness of an assets return that results from interest-rate changes
if an investors holding period is longer than the term to maturity of the bond, the investor is expos
type of interest-rate risk because the proceeds from the short-term bond need to be reinvested at
interest rate that is uncertain
the average lifetime of a debt securitys stream of payments