business finance exam 2

ch 5 part 2

starts here

what type of rates are APR and EAR

annual rates

what is the rate used in formulas for solving things

r, which is periodic rate

r =

APR / m

effective annual rate - what is it

The true, total interest rate paid or earned in one year after accounting for the effects of compounding

apr vs ear

both measure how much it takes to borrow money, but apr doesn’t account for interest compounding while EAR does.

apr = a simple annual multiplier

nominal rate

unadjusted + stated interest rate on a loan

real rate

adjust the nominal rate for inflation - shows true purchasing power + borrowing cost

are EAR and APR real or nominal

all are nominal - because they only tell you how fast your money grows in $$ and not how many more goods you can buy

what is “real gain” in terms of

in terms of real goods/purchasing power, not just how much more money you made

how to find real purchasing power

take the APR and convert it to the EAR to find stuff in terms of how many goods you can buy

rise in price is

inflation

inflation is the…

rate of change in the general price level

nominal vs real interest rate

Nominal = % increase in dollars the investor receives from investing (what the bank quotes with EAR, APR and r)

Real = % increase in goods and services the investor can buy from investing (what you care about)

what does it mean if the nominal rate is no higher thna inflation

saving in the bank is worse than buying goods today

fisher equation

shows how the nominal, real and inflation are all connected

fisher equation shows…

how the nominal, real and inflation are all connected

fisher equation

fisher equation approximation

chapter 6 starts here

yes!

components of a bond

the coupon and the par value

coupon vs par

price of a coupon bond formula = what are the components

the coupon (annuity) and a par value (the lump sum)

what is YTM

• a type of APR

• a discount rate

• purpose: find PV of the bonds cash flows = market price, if bond it held to maturity

is YTM market determined

yes!

how to solve for YTM with calc

PMT and FV = same sign. PV = opposite sign

calculator returns r=YTM/m, so you have to multiply by m

rules to find YTM on calculator

YTM on Calculator:

• Market determined

• PMT & FV = same sign. PV = opposite sign

• Calculator returns r = YTM/m, multiply by m to get YTM

• If you’re given the YTM and you need to solve for PMT or something else, you say that I% = (YTM / m) = little r

for YTM, what does the calculator return?

• Calculator returns r = YTM/m, multiply by m to get YTM

• If you’re given the YTM and you need to solve for PMT or something else, you say that…

• I% = (YTM / m) = little r

• so, you have to divide the YTM by m!!!!!

PAR BOND

YTM = coupon rate, then price = par value

PREMIUM BOND

YTM < coupon rate then price > par value

discount bond

YTM > coupon rate, then price < par value

longer maturity =

more price risk, aka more sensitive to a change in yield than the 1 year bond

coupon rate

capital gain yield

•  the percentage change in the price of an asset over time, reflects price appreciation (if it’s a discount bond) or depreciation (if it’s a premium bond)

CURRENT YIELD

annual coupon / price. Coupons are always POSITIVE, so the current yield can never be negative

summary of premium bond

summary of discount bond