FIN 3303 1st Edition Lecture 7 Outline of Current Lecture II Interest Rate III Example Problems IV Bonds V Example Problems Current Lecture I II III IV V VI VII VIII Nominal vs Real Interest Rate Time 0 a You have 1000 b r 100 c Basket of goods and services i 500 each ii Can have 2 baskets Time 1 year a You will have 2000 b Baskets of goods and services i 500 ii Can now have 4 baskets c Purchasing power has increased Inflation a General rise in price levels What if inflation is 100 a Basket will then cost 1000 i Now can only consume 2 baskets in year 2 b Real interest rate 0 c Nominal Interest rate 100 d Inflation rate 100 Nominal Rate a Growth rate of money rnom rreal rinflation Real Rate a Growth rate of purchasing power i 1 rnom 1 rreal x 1 rinlfation Example a Inflation rate is 6 per year and nominal interest rate is 10 per year The real interest rate in this case is closet to These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute i 1 1 1 rreal x 1 06 ii rreal 1 1 1 06 1 iii rreal 0377 or 3 77 IX X XI XII Bond a Long term debt instrument b Two Payments i Coupon Payment Interest Payment ii Par Value Face Value 1 Note IF par value is not given in a problem assume it is 1000 Example a Maturity is 5 years coupon rate is 10 bond costs 950 What is your average annual return i N 5 PV 950 PMT 100 FV 1000 I Y 11 4 b A 5 year 10 coupon bond coupons paid semi annually with a face value of 1000 is priced at 950 What is the YTM i N 10 I Y 5 67 PV 950 PMT 50 FV 1000 1 The I Y found was for 6 months and not a year In this case take the I Y and multiply by 2 to find the YTM 5 67 x 2 11 337 Zero Coupon Bonds a No payments during bond life Example a A 5 year zero coupon bond Par value is 1000 and is priced at 900 What is the YTM i N 5 I Y 2 13 PV 900 PMT 0 FV 1000 b A 5 year 10 coupon bond Par value is 1000 and the YTM 12 What is the PV i N 5 I Y 12 PV 928 PMT 100 FV 1000 1 If interest rates go up bonds will go down a Bad news