Professional Documents
Culture Documents
Course Introduction and Basics of Interest Theory
Course Introduction and Basics of Interest Theory
12
13
Assessment
Homework (30%)
I
Exams (60%)
I
Final exam
Writing project (10%): 3-page essay, due before the final exam
14
15
Course materials
Required textbook: Mathematical Interest Theory by L. Vaaler and J.
Daniel.
Lecture notes/slides
In the last week, we will watch a documentary film Floored about people and
business of the trading floors.
Financial calculator (optional)
I
Course content
1. Time Value of Money
Chapter 1 and 2
Interest, discount, accumulation function, equation of value
2. Annuities
Chapter 3 and 4
Annuities/cash flows of different types
3. Loan / Chapter 5
4. Bond / Chapter 6
5. Immunization
Chapter 9
Duration, convexity
6. Equity market
16
17
Homework
Posted on the Blackboard system every Thursday.
Due back next Thursday at the end of the class.
You need to write down detailed steps of computation for each question.
Unless you have very very very special reason,
I
I
18
What is interest?
If an investment amount $ K grows to an amount $ S, then the difference $
S K is interest.
Economic rationale for the charing of interest:
I
default risk
Formulas
I
Ak (t) = Ka(t)
Examples
I
19
1 10
Formulas
a(t2 )a(t1 )
a(t1 )
i[t1,t2] =
in = i[n1,n]
1 11
Formulas
I
Examples
I
1 12
Discount rate
Definitions
I
Formulas
a(t2 )a(t1 )
a(t2 )
dn =
a(n)a(n1)
a(n)
Examples
I
Example 1.6.5
1
(1d1 )(1d2 )...(1dn )
1 13
Formulas
I
d
1d .
d=
1 14
1
a(t)
Formulas:
1
1+i
=1d
discount factor v =
1 15
nominal rate is the rate quoted by banks, not equal to the effect rate
i(m): a nominal interest rate that convertible/compounded/payable m
times per year
d(m): a nominal discount rate that convertible/compounded/payable m
times per year
APY (annual percentage yield): the effect compound interest rate
Formulas
I
i(m) = m[(1 + i) m 1]
1 16
1
d(m) m
) , d(m) = m[1 (1 d) m ]
d = 1 (1
m
I relation between the nominal rates of interest and discount:
(m)
d(m)
1
d(m)
m
(m)
i(m)
(m)
1 + im
Example: Helen borrows $ 5000 from her credit card account at a nominal
annual interest rate of 20% per year convertible monthly. Two months later,
she pays $1000 back. Four months after the payment she borrows $ 2000.
How much does she owe one year after the loan is taken out?
1 17
1 18
1 19
Inflation rate:
p(t2) p(t1)
p(t1)
For US inflation rate, p is Consumer Price Index published monthly by
Bureau of Labor Statistics.
r[t1,t2] =
ir
1+r
Examples
I
Example 1.14.6