econ 330 chapter 4

Subprime financial crisis

A financial crisis that began due to the collapse of mortgage-backed securities, leading to significant declines in credit markets.

Present value

The current worth of a future sum of money given a specified rate of return.

Yield to maturity

The interest rate that equates the present value of future cash flows of a bond to its current price.

Nominal interest rate

The interest rate before adjusting for inflation.

Real interest rate

The interest rate adjusted for inflation.

Coupon bond

A bond that pays fixed interest payments until maturity, at which point the face value is repaid.

Discount bond

A bond that is sold for less than its face value and pays its face value at maturity without periodic interest payments.

Interest rate risk

The risk associated with fluctuating interest rates affecting the value of a bond.

Capital gain

An increase in the value of an asset that gives it a higher worth than the purchase price.

Current yield

The annual income (interest or dividends) divided by the current price of the security.

Fisher equation

A formula stating that the nominal interest rate is the sum of the real interest rate and the expected inflation rate.

Inflation

The rate at which the general level of prices for goods and services is rising.

Bond pricing formula

The formula used to calculate the price of a bond, which is the present value of its future cash flows.

Yield to call (YTC)

The total return anticipated on a callable bond if it is held until the call date.

Duration

A measure of the sensitivity of a bond's price to changes in interest rates, reflecting the bond's maturity and cash flow timing.

Current price of zero-coupon bond

Calculated using the formula P = F / (1 + r)^n, where P is the price, F is the face value, r is the yield, and n is the number of years to maturity.

Loan amortization formula

A formula used to determine the periodic payment on a loan, which includes principal and interest, typically expressed as P = [r*PV] / [1 - (1 + r)^-n], where PV is the present value (loan amount), r is the periodic interest rate, and n is the number of periods.

Net present value (NPV)

The difference between the present value of cash inflows and the present value of cash outflows over a period of time.

Modified duration

A measure of a bond's sensitivity to interest rate changes, calculated as the Macaulay duration divided by (1 + yield).

Callable bond formula

The price of a callable bond can be calculated as the minimum of the present value of expected cash flows assuming no call and the present value of cash flows assuming the bond is called at the earliest possible date.