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1、Principles of Financial MarketsTIANFU COLLEGE OF SWUFEChapter 3Understanding Interest RatesChapter PreviewlSince interest rates are among the most closely watched variables in the economy, it is imperative that what exactly is meant by the phrase interest rates is understood. lIn this chapter, we wi
2、ll see that a concept known as yield to maturity (YTM) is the most accurate measure of interest rates.7/21/20242FM 姜程Chapter PreviewlIn this chapter, we develop a better understanding of interest rates. We examine the terminology and calculation of various rates, and we show the importance of these
3、rates in our lives and the general economy. 7/21/20243FM 姜程Topics include:lMeasuring Interest RateslThe Distinction Between Real and Nominal Interest RateslThe Distinction Between Interest Rates and Returns7/21/20244FM 姜程1. Measuring Interest RateslThere are four basic types of credit instruments:Si
4、mple LoanlCommercial loans to businessesFixed Payment LoanlInstallment loans and mortgagesCoupon BondlTreasury bonds, Treasury notes and Corporate bondsDiscount BondlTreasury bills7/21/20245FM 姜程1) Present ValuelThe concept of present value is based on the commonsense notion that a dollar of cash fl
5、ow paid to you one year from now is less valuable to you than a dollar paid to you today. lThis notion is true because you could invest the dollar in a savings account that earns interest and have more than a dollar in one year.7/21/20246FM 姜程1) Present ValuelThe term present value (PV) can be exten
6、ded to mean the PV of a single cash flow or the sum of a sequence of group of cash flows.7/21/20247FM 姜程Present Value Concept: Simple Loan TermslLoan Principalthe amount of funds the lender provides to the borrower.lMaturity Datethe date the loan must be repaid; the Loan Term is from initiation to m
7、aturity date.lInterest Paymentthe cash amount that the borrower must pay the lender for the use of the loan principal.7/21/20248FM 姜程Present Value Concept: Simple Loan TermslSimple Interest Ratethe interest payment divided by the loan principal; the percentage of principal that must be paid as inter
8、est to the lender. Convention is to express on an annual basis, irrespective of the loan term.7/21/20249FM 姜程Present Value Concept: Simple Loan7/21/202410FM 姜程2) Yield to MaturitylYield to maturityThe interest rate that equates the present value of payments received from a debt instrument with its v
9、alue today.To understand the yield to maturity better, we look at how it is calculated for the 4 types of debt instruments.7/21/202411FM 姜程(1) Simple LoanlFor simple loan, the simple interest rate equals the yield to maturity7/21/202412FM 姜程Present Value Concept:Fixed-Payment Loan TermslFixed-Paymen
10、t Loan are loans where the loan principal and interest are repaid in several payments, often monthly, in equal dollar amounts over the loan term.lInstallment Loans, such as auto loans and home mortgages are frequently of the fixed-payment type.7/21/202413FM 姜程(2) Fixed-Payment Loan7/21/202414FM 姜程Pr
11、esent Value Concept: Coupon BondlA coupon bond pays the owner of the bond a fixed interest payment every year until the maturity date, when a specified final amount (face value or par value) is repaid.7/21/202415FM 姜程(3) Coupon BondFixed coupon payments of $C forever7/21/202416FM 姜程Relationship Betw
12、een Price and Yield to MaturitylWhen bond is at par, yield equals coupon ratelPrice and yield are negatively relatedlYield greater than coupon rate when bond price is below par value.7/21/202417FM 姜程Present Value Concept: Discount BondlA discount bond is also called a zero-coupon bond. It is bought
13、at a price below its face value, and the face value should be repaid at the maturity date.7/21/202418FM 姜程(4) Discount Bond7/21/202419FM 姜程2.Other Measures of Interest RateslBecause the yield to maturity is difficult to calculate, less accurate measures of interest rates have come into common use in
14、 bond markets.Current YieldYield on a discount basis7/21/202420FM 姜程1) Current Yieldlic=C/PlCurrent yield (CY) is just an approximation for YTM easier to calculate. However, we should be aware of its characteristics:If a bonds price is near par and has a long maturity, then CY is a good approximatio
15、n.A change in the current yield always signals change in same direction as yield to maturity7/21/202421FM 姜程2) Yield on a Discount BasislTwo characteristicsUnderstates yield to maturity; longer the maturity, greater is understatement.Change in discount yield always signals change in same direction a
16、s yield to maturity.lOne-Year Bill (P = $900, F = $1000)7/21/202422FM 姜程3. Distinction Between Real and Nominal Interest RateslReal interest rateInterest rate that is adjusted for expected changes in the price levelir=i-eReal interest rate more accurately reflects true cost of borrowingWhen real rat
17、e is low, greater incentives to borrow and less to lend7/21/202423FM 姜程3. Distinction Between Real and Nominal Interest RatesReal interest ratelWe usually refer to this rate as the ex ante real rate of interest because it is adjusted for the expected level of inflation. After the fact, we can calcul
18、ate the ex post real rate based on the observed level of inflation.7/21/202424FM 姜程U.S. Real and Nominal Interest RatesSample of current rates and indexeshttp:/ 姜程4. Distinction Between Interest Rates and ReturnslRate of ReturnRET=where ic=C/Pt=current yieldg=(Pt+1-Pt)/Pt=capital gain7/21/202426FM 姜
19、程Key Facts about the Relationship Between Rates and Returns7/21/202427FM 姜程Key Facts about the Relationship Between Rates and ReturnslOnly bond whose return= yield is one with maturity = holding periodlFor bonds with maturity holding period, iP implying capital losslLonger is maturity, greater is pr
20、ice change associated with interest rate changelLonger is maturity, more return changes with change in interest ratelBond with high initial interest rate can still have negative return if i7/21/202428FM 姜程Maturity and the Volatility of Bond ReturnslConclusion from Table 3-2 analysisPrices and return
21、s more volatile for long-term bonds because have higher interest-rate riskNo interest-rate risk for any bond whose maturity equals holding period7/21/202429FM 姜程Reinvestment RisklOccurs if hold series of short bonds over long holding periodli at which reinvest uncertainlGain from i, lose when i7/21/
22、202430FM 姜程Formula for DurationlKey facts about durationAll else equal, when the maturity of a bond lengthens, the duration rises as wellAll else equal, when interest rates rise, the duration of a coupon bond fall7/21/202431FM 姜程Formula for DurationlThe higher is the coupon rate on the bond, the sho
23、rter is the duration of the bondlDuration is additive: the duration of a portfolio of securities is the weighted-average of the durations of the individual securities, with the weights equaling the proportion of the portfolio invested in each7/21/202432FM 姜程Duration and Interest-Rate RisklThe greate
24、r is the duration of a security, the greater is the percentage change in the market value of the security for a given change in interest rateslTherefore, the greater is the duration of a security, the greater is its interest-rate risk7/21/202433FM 姜程SummarylMeasuring Interest Rates: We examined seve
25、ral techniques for measuring the interest rate required on debt instruments.lThe Distinction Between Real and Nominal Interest Rates: We examined the meaning of interest in the context of price inflation.lThe Distinction Between Interest Rates and Returns: We examined what each means and how they should be viewed for asset valuation.7/21/202434FM 姜程
