What happens to a future value if the rate is increased?

The future value

gets larger.

What happens to a present value if the rate is increased? The present value
gets smaller.

What is an annuity? A finite series of equal payments which are the same
amount and have same amount of time between each payment.

Two types of annuities.

Use PMT key to calculate annuity payment

Ordinary annuity- the receipt or the payment is made at the end of the period.

Annuity due- the payment or receipt occurs at the beginning of the period.
Since the payment or receipt is made at the beginning of the period, that that
means that there is ONE more additional compounding period as compared to
an ordinary annuity.

- Annuity due will always have a higher PV and FV because there is less
discounting with PV and more compounding with FV.

There is an inverse relationship between interest rate and PV of annuity.

Perpetuity- payments which go on indefinitely. For e.g., dividends paid on

preference shares. Unending equal payments paid at equal time intervals

Formula for present value of a perpetuity- amount paid indefinitely which is

the cash flow, divided by interest rate. C/R

Effective Annual Rate and Annual Percentage Rate

APR- annual rate quoted by law APR= rate* number of periods

Period rate= APR/ Number of periods

What is the APR if the semiannual rate is 5%

semiannual rate, therefore multiple by 2

5%*2= 1%

What is APR if the monthly rate is 5%

5%*12= 6%

EFR= this is the actual rate given the number of compounded periods
CHAPTER 7- INTEREST RATES AND BONDS VALUATION
In this session the learning objectives are;

•Define important bond features and types of bond;

•Explain bond values and yields and why they fluctuate.
•Describe bond ratings and what they mean;
•Outline the impact of inflation on interest rates.

What is a bond? A bond is a investment that represents a loan made by an

investor to a borrower, usually corporate or government.

An investment issued by governments and corporations when they want to raise

money.

It is a debt instrument

How a bond works- you buy the bond at the par value, the government or
corporations will pay you interest on the bond periodically, then repay you the
par value at the end of the life of the bond/ maturity date.

Yield or yield to maturity is-

Par value/face value- the principal amount. The amount repaid at maturity
Coupon rate- dictates the interest payment that you will get per period. What is
used to determine the annual interest payments = annual coupon divided by
face value

Interest you will receive= coupon rate* principle amount

Rate of return is the yield. This is used as the discount rate to find the PV of
the bond. The yield influences the price of the bond

The price of the bond- is the present value of the bond.

Bond value – PV of coupons + PV of par/ face value

Bond value – PV of annuity + PV of lump sum

lump sum - this is the future value/face value/ par value of the bond. Which is
the amount that is expected to be received at the end of the time when the bond
matures.

THERE IS AN INVERESE RELATIONSHIP BETWEEN YEILDS AND

PRICES. As yields go up, bond prices go down and vice versa.

worthiness of corporation or government.

By buying a bond you are giving the issuer a loan and they agree to pay you
back the face value of the loan on a specific date and you pay periodic interest
payments.

What are bond ratings? Bond ratings are representations of the credit

The ratings are published by credit rating agencies.

The relationship between the yield and the coupon- if the yield to maturity is
equal to the coupon, then the par vale is equal to the par value. This is a bond
that sells as par.

Discount bond- If yield to maturity is greater than coupon then par value is
higher than bond price. Also if the bond price is less than par value

Premium bond- If yield to maturity is less than coupon, then par value is less
than bond price. Higher coupon rate causes present value above par.

The selling price/ pv/ market price is higher than face value/ fv. Therefore the
yield would be less than the coupon

CURRENT YIELD VS YIELD TO MAUTURITY

Yield to maturity is the required rate of return on the bond=

Current yield+ capital gains yield

The yield to maturity is used as the discount rate/ required return This
influences the price of the bond.

There is an inverse relationship between yields and prices. As yields go up,

bond prices go down and vice versa a

Capital gains yield any additional movement in the price of the security (price
of the bond) if the bond price moves from one price to another and decreases,
that is a bond loss/ capital gains reduction.

Formula: what it is- what was paid/ beginning price

Current yield= annual coupon of the bond/ price

Interest payments are determined by the coupon rate. Interest payments are=
coupon rate percentage* par value of bond
Difference between DEBT and EQUITY

Last 15 mins of lecture

If an amount is given always assume it is the PV unless stated otherwise

PV is equal to one in some cases when not given