OBJECTIVES

Ò Understand principles of interest rate and

Fisher equation
Principles of Financial Market Ò Understand and apply methods of valuating
interest rate
Ò Understand factors affecting interest rate
CHAPTER 6: INTEREST RATE
Ò Understand principles of interest rate ‘s term
and risk structure

1. DEFINITION THE IMPORTANCE ROLE OF INTEREST RATE

Ò Interest rate is the price of using a unit of loan Ò Why should firms/investors/households/
(usually money) over a given period of time. government be concerned with changes in
interest rate?
Ò the proportion of an amount loaned which a
Ò à a trade-off between present and future
lender charges as interest to the borrower,
consumption.
normally expressed as an annual percentage. It
Ò à spending, saving, financial & physical
is the rate a lender charges to borrow its
capital allocation
money, or the rate a bank pays its savers for
Ò à geometry of the economy, distribution of
keeping money in an account.
labor & resources.

2. CLASSIFICATION 2. CLASSIFICATION

2.1. Based on banking business: 2.2. Based on the value of interest:

§ Deposit rate (saving rate) Ò Nominal interest rate: The interest rate account

§ Rate for loan (borrowing rate) for the nominal value of the currency, not
including the inflation rate. Often published
§ Discount rate
officially in credit contracts or on debt
§ Interbank interest rate
instruments.
§ Basic interest rate
Ò Real interest rate: the interest rate adjusted by
change in expected inflation rate.
 EX (FISHER EQUATION) EX (FISHER)

Ò Suppose nominal interest is 15.5%; expected Ò Suppose Sam owns an investment portfolio.
inflation rate is 5%. Please caculate real Last year, the portfolio earned a return of
interest? 3.25%. However, last year’s inflation rate was
A. 10.5% around 2%. Sam wants to determine the real
B. 20.5%
return he earned from his portfolio.
C. 10.0%

2. CLASSIFICATION
IMPLICATIONS FROM FISHER EQUATION
2.2. Based on the value of interest : (cont.)
Ò The relationship between nominal and real interest rate Ò When real interest rate is low, borrower will
is expressed by Fisher equation: (approximate version) have more incentive to borrow and lender will
i = ir + πe have less incentive to lend
Where, i: nominal interest rate Ò When inflation is expected to increase, the
ir : real interest rate nominal interest rate is needed to increase in
πe : expected inflation rate(*) order to ensure a positive real interest rates

NEGATIVE NORMINAL INTEREST RATE IN HISTORY

QUESTION
Ò 1990s Japan: The stock market collapse and
Ò Can real interest rate be negative? When? poor economy prompted local investors to buy
safe government bonds, dropping yields to
Ò Can nominal interest rate be negative?
negative levels at times.
Explain the meaning of negative nominal
Ò 2009 Sweden: During the financial crisis,
interest rate? Sweden had a brief spell of negative nominal
rates on short-term deposits.
Ò 2012 Europe: Belgium, France, Germany and
Netherlands sold short-term government bonds at
small negative nominal rates. Denmark and
Switzerland cut deposit rates below zero, as
investors sought refuge from the Euro currency.
2. CLASSIFICATION 3. VALUATING INTEREST RATE

2.3. Based on the flexibility of interest rate: Ò Fourtypes of Credit

§ Fixed rate Market Instruments
§ Floating rate Ò Simple loan
2.4. Based on types of currency for lending:
Ò Fixed payment loan
§ Domestic currency interest rate
§ Foreign currency interest rate Ò Coupon bond

2.5. Based on the credit source: Ò Discount bond

§ Domestic rate
§ International rate

3. VALUATING INTEREST RATE 3.1. INSTRUMENTS OF CREDIT MARKET

3.1. Instruments of credit market: 3.1.2. Fixed repayment loan: is the loan method
3.1.1. Simple loan: A loan as a borrower will pay by which the borrower repays the loan by paying
the lender the principal and an interest as the the fixed amount after a fixed period of time
cost of using the loan at maturity.. throughout the loan period.
Example: borrow 100mil for 1 year, 10%/yr Example: you borrow the bank 1bil to buy
borrowing rate. After 1 year, you have to pay house for 15 years and each year you have to
110mil (100mil as the principle and 10mil as repay the bank 150mil (including part of
interest) principle and interest)

A 1 BILLION VND FIXED PAYMENT LOAN WITH PMT = A 1 BILLION VND FIXED PAYMENT LOAN WITH PMT =
263.8M IN 5Y 117.46M IN 20Y
3.1. INSTRUMENTS OF CREDIT MARKET 3.1. INSTRUMENTS OF CREDIT MARKET

3.1.3. Coupon bond: Bond that pay interest as a 3.1.4. Discound bond (zero cpupon bond): a bond
coupon periodically until the maturity. At is sold at a price lower than the face value. At
maturity, the bondholder will receive the face maturity, the bondholder will receive the face
value of the bond value. This kind of bond does not pay coupon.
Example: A 5 year bond has a face value of Example: Treasury bond has a face value of
50m, 10%/yr coupon rate, paid annually. The 10mil, sold at a price of 9mil, 1 year maturity.
bond price is 50m VND

MEASURING INTEREST RATE –

TIME VALUE OF MONEY WHY TIME?

Which would you prefer -- $10,000 today Why is TIME such an important element
or $10,000 in 5 years? in your decision?

Obviously, $10,000 today. TIME allows you the opportunity to postpone

consumption and earn INTEREST.
You already recognize that there is TIME
VALUE TO MONEY!! Other factors: inflation, risk, opportunity
cost

3. VALUATING INTEREST RATE SIMPLE INTEREST FORMULA

3.2Time value of money:
3.2.1. Simple interest:
Ò The interest rate is calculated on the principal only. The
interest is not included to the principle to calculate Formula SI = P0(i)(n)
interest for the next period.
Ò Used for credit contract with 1 year maturity or shorter.
Ò Since simple rate is usually in the form of % per annum,
SI: Simple Interest
you want to calculate the interest rate for a given term, P0: Deposit today (t=0)
first calculate the term in how much part of a year then
multiply it with the simple rate. i: Interest Rate per Period
For example: if the simple rate is 16%/yr then the simple n: Number of Time Periods
rate for 2-year is 32%, 6-month is 8%.
SIMPLE INTEREST EXAMPLE SIMPLE INTEREST (FV)

Ò Assume that you deposit $1,000 in an Ò What is the Future Value (FV) of the deposit?
account earning 7% simple interest for 2
years. What is the accumulated interest at FV = P0 + SI
the end of the 2nd year? = $1,000 + $140
= $1,140
Ò SI = P0(i)(n)
= $1,000(.07)(2) Ò Future Value is the value at some future time of
= $140 a present amount of money, or a series of
payments, evaluated at a given interest rate.

DOES ANYONE HAVE ANY INTEREST IN INTEREST?

SIMPLE INTEREST (PV)

• Very few banks today pay interest based on the

Ò What is the Present Value (PV) of the simple interest formula. Instead, they pay
previous problem? interest by using a principle called
The Present Value is simply the compounding.
$1,000 you originally deposited. Ò The difference between simple and compound
That is the value today! interest is this: Simple interest grows slowly,
Ò Present Value is the current value of a future compounding speeds up the process.
amount of money, or a series of payments,
evaluated at a given interest rate.

THE POWER OF COMPOUND INTEREST

HOW IT WORKS.

Ò When Albert Einstein was once Simple interest is interest on the principle
asked what mankind's greatest
invention was, he replied: amount.
"Compound interest." There's
even one claim that Einstein
called compound interest the "8th Compound interest is when your principle and
Wonder of the World.” any earned interest both earn interest.

Ò Money makes money. And the

money that money makes, makes
money.”( Benjamin Franklin)
 CONSIDER THIS EXAMPLE: YOU BEGIN WITH
$100 INVESTED AT 10% ANNUAL INTEREST. WHY COMPOUND INTEREST?

After Simple Interest Compound

Interest Future Value of a Single $1,000 Deposit
1 year 110 110
2 years 120 121 20000

Future Value (U.S. Dollars)

3 years 130 133 10% Simple
15000 Interest
4 years 140 146
10000 7% Compound
5 years 150 161 Interest
10 years 200 259 5000 10% Compound
Interest
20 years 300 672
0
50 years 600 11,739 1st Year 10th 20th 30th
Year Year Year

FUTURE VALUE
SINGLE DEPOSIT (GRAPHIC)

Assume that you deposit $1,000 at a

LOOK compound interest rate of 7% for 2 years.
HOW
COMPOUNDING
WORKS! 0 1 2
7%

$1,000
FV2

FUTURE VALUE Future Value

SINGLE DEPOSIT (FORMULA) Single Deposit (Formula)

FV1 = P0 (1+i)1 = $1,000 (1.07) FV1 = P0 (1+i)1 = $1,000 (1.07)

= $1,070 = $1,070
Compound Interest FV2 = FV1 (1+i)1
You earned $70 interest on your $1,000 = P0 (1+i)(1+i) = $1,000(1.07)(1.07)
deposit over the first year. = P0 (1+i)2 = $1,000(1.07)2
This is the same amount of interest you = $1,144.90
would earn under simple interest. You earned an EXTRA $4.90 in Year 2 with
compound over simple interest.
GENERAL FUTURE VALUE FORMULA 3. VALUATING INTEREST RATE
3.2.2. Compound interest:
Ò When loan contract has multiple periods of interest, the interest
accrued in the preceding period is added to the principal for interest
FV1 = P0(1+i)1 calculation for the next period, the method of calculating such interest
FV2 = P0(1+i)2 is called the compound interest rate.
Ò Usually applied for long term contract (longer than 1 year)
etc.
Ò Formula:
General Future Value Formula: FV = PV x (1 + i/n)n.t
FVn = P0 (1+i)n FV= PV.(1+i)n
CI= PV(1+i)n – PV = PV[(1+i)n-1]
Where,
P: present value; FV: future value
i: compound interest rate (%/year)
t: the maturity in term of year
n: the number of periods interest paid in one year

EXAMPLE: $100 IS INVESTED AT 10% INTEREST

ANOTHER VERSION OF COMPOUND INTEREST FORMULA COMPOUNDED YEARLY FOR 6 YEARS

nt
⎛ r⎞
A = p ⎜1 + ⎟
⎝ n⎠
A—Total amount
p —principle
r —interest rate
n —number of compounding periods
t —time in years

177.16

$250 INVESTED AT 6.5% FOR 8 YEARS

COMPOUNDED MONTHLY.
COMPOUND INTEREST
3.2.2. Compound interest
Example:
a. $1000 at 7.25% for 9 years compounded monthly.
b. A customer buy a bond with 2-year maturity,
12%/year compound interest rate. Interest is
paid each 6-month. What is the future value the
customer receive?
c. If you want to have 1bil after 30 years, how much
you have to save today. Known that the
compound interest rate of the bank is 10%/year.
419.92
EX1
DOUBLE YOUR MONEY!!!
Ò At the beginning of 2020, Mr. Tony
made a deposit of 50 million VND for a Quick! How long does it take to double
12-month term. The interest rate $5,000 at a compound rate of 12% per
announced by the bank is 8%. How year (approx.)?
much money does Tony receive at the
end of 2025? By the end of 2028?
(Assuming that Tony's deposit is
We will use the “Rule-of-72”.
renewed automatically.)

THE “RULE-OF-72” EX2A: “ENRICHMENT IS NOT DIFFICULT”

Ò On your seventieth birthday, you learn that your

Quick! How long does it take to double grandma, bless her soul, deposited $50.00 for you
$5,000 at a compound rate of 12% per on the day of your birth in a savings account
year (approx.)? bearing 5 percent interest. How much is in the
account?

Approx. Years to Double = 72 / i%

72 / 12% = 6 Years
[Actual Time is 6.12 Years]

EX2A: “ENRICHMENT IS NOT DIFFICULT” EX2B: “ENRICHMENT IS NOT DIFFICULT”

Ò GoodMan and BadMan are two students

Ò Your ancestors left you with an that recently graduated from college.
inheritance. Knowing that this They has started a business at the age of
22 and both of them earn $ 30,000 per
inheritance is initially worth $1 and is
year. GoodMan lives in a country that
deposited at a “trustworthy bank” with has the economic growth rate of 3% per
an interest rate of 5% at the time of year meanwhile the economy in which
Jesus' birth. How much money do you BadMan is living has the growth rate of
have now? Are you richer than the 1%.When both are 62 years old, how
richest billionaire in the world today? much money will each person make each
year?
EX3 COMPOUNDING PERIOD
Ò Ms. Anh put 100 million VND in three-month term
deposit. Calculate the amount Ms. Anh receive v The period between the points when interest
after 1 year, knowing that the interest rate of the is paid or when it is added to principal
bank is announced as follows: v The more frequent the compounding period,
the more valuable the bond or other
instrument, all else constant
v EX: $680 at 5.5% for 1.5 years compounded
monthly. Calculate the interest you earn
after one and a half year?

EX 4 EX 5
Ò Ms. Anh wants to buy an Emerald apartment
in Thu Duc City. Real estate staff advises Ò You won the lottery and you have two
Ms.Anh with 2 payment options as follows: options to receive the monetary reward
Ò (1) Upon purchase, pay immediately 600m Ò (a) receive 1.5 billion VND immediately
VND, then 240m VND each year in 2 years Ò (b) Receive 150 million per year for 20
later. years.
Ò (2) Pay upon purchase 1 billion VND.
Ò Suppose the interest rate is 8%
Ò Knowing that interest rate is 14%, all else
(average expected return rate)
constant . Which option should you
recommend for Ms. Anh?. à Which option should you go with?

COMPONENTS OF AN ANNUITY COMPONENTS OF AN ANNUITY DUE

(Ordinary Annuity) Annuity Due

End of End of End of Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3 Period 1 Period 2 Period 3

0 1 2 3 0 1 2 3

$100 $100 $100 $100 $100 $100

Today
Equal Cash Flows Today
Equal Cash Flows
 FV OF AN ANNUITY FV OF AN ANNUITY

Cash flows occur at the end of the period Cash flows occur at the end of the period
0 1 2 n 0 1 2 3 4
i% . . . 7%

PMT PMT PMT $1,000 $1,000 $1,000

PMT = Periodic $1,070
Cash Flow
$1,145
FVA3 = $1,000(1.07)2 +
FVAn = PMT(1+i)n-1 + PMT(1+i)n-2 + FVAn $1,000(1.07)1 + $1,000(1.07)0 $3,215 = FVA3
... + PMT(1+i)1 + PMT(1+i)0 = $1,145 + $1,070 + $1,000
= $3,215

FV OF AN ANNUITY DUE FV OF AN ANNUITY DUE

Cash flows occur at the beginning of the period

Cash flows occur at the beginning of the period
0 1 2 3 n-1 n
i% . . . 0 1 2 3 4
7%
PMT PMT PMT PMT PMT
$1,000 $1,000 $1,000 $1,070

$1,145
$1,225

FVADn FVAD3 = $1,000(1.07)3 +

FVADn = PMT(1+i)n + PMT(1+i)n-1 + $1,000(1.07)2 + $1,000(1.07)1
$3,440 = FVAD3
... + PMT(1+i)2 + PMT(1+i)1
= $1,225 + $1,145 + $1,070
= FVAn (1+i) = $3,440

FUTURE VALUE (FV) FORMULA PV OF AN ANNUITY

Ò FV or an amount: FV = PV* (1+i)n
Cash flows occur at the end of the period
Ò Ordianry annuity 0 1 2 n n+1
i% . . .

(1+ i)n − 1
FVA = PMT PMT PMT PMT
i
PMT = Periodic
Ò Annuity due Cash Flow
PVAn
(1+ i)n − 1 PVAn = PMT/(1+i)1 +
FVAD = PMT (1+ i) PMT/(1+i)2 + ... + PMT/(1+i)n
i
 PV OF AN ANNUITY PV OF AN ANNUITY DUE

Cash flows occur at the end of the period Cash flows occur at the beginning of the period
0 1 2 3 4 0 1 2 n-1 n
7% i% . . .

$1,000 $1,000 $1,000 PMT PMT PMT PMT

$ 934.58
$ 873.44
$ 816.30 PMT: Periodic
$2,624.32 = PVA3 PVA3 = $1,000/(1.07)1 + PVADn Cash Flow
$1,000/(1.07)2 +
$1,000/(1.07)3 PVADn = PMT/(1+i)0 + PMT/(1+i)1 + ... +
= $934.58 + $873.44 + $816.30 PMT/(1+i)n-1 = PVAn (1+i)
= $2,624.32

PV OF AN ANNUITY DUE FORMULA OR PRESENT VALUE (PV)

v PV of an amount
Cash flows occur at the beginning of the period
PV0 = FVn / (1+i)n
0 1 2 3 4 Ò PV of an ordinary annuity
7%
1− (1 + i)-n
$1,000.00 $1,000 $1,000 PVA = PMT
$ 934.58 i
$ 873.44
Ò PV of an annuity due
$2,808.02 = PVADn
1− (1 + i)-n
PVADn = $1,000/(1.07)0 + $1,000/(1.07)1 + PVAD = PMT (1+ i)
$1,000/(1.07)2 = $2,808.02 i

PRACTICE 3. VALUATING INTEREST RATE

Ò You won $1 million in the lottery but unfortunately the money 3.2. Time value of money :
is payable in a year and you want to start spending it right 3.2.3. Effective interest rate:
away. If interest is at 8 percent, how much can you receive
Ò The real interest rate arises in a year, depending on the
today in exchange for that $1 million in year?
Ò You won the lottery and netted a million bucks, but you need nominal interest rate stated in the contract and the
$5 million to buy a little island that you have had your eye number of period interest paid in one year
on. If interest is at 12 percent, will you be able to buy your Ò Formula:
island in 30 years, assuming its price is unchanged at that
time? ief = (1+i/n)n -1
Ò You’ve won a scholarship for your senior year worth $1,500, Where,
but it is payable only after graduation, a year hence. If ief: effective interest rate (%/year)
interest is at 15 percent, how much is your scholarship worth
today? i : nominal interest rate(%/year)
Example: Calculate the effective interest rate if the interest is
paid each 6-month, 3-month, 1-month known that the
nominal interest rate stated in the contract is 12%/year.
3. VALUATING INTEREST RATE
3.3. Yield to maturity (YTM or Yield) 3.3.1. Yield to maturity of simple loan:
YTM: The percentage rate of return for a bond
assuming that the investor holds the asset until its Ò Ex: If Pete borrows $100 from his sister and
maturity date. It is the sum of all of its remaining next year she wants $110 back from him, what
coupon payments. A bond's yield to maturity rises is the yield to maturity on this loan?
or falls depending on its market value and how
many payments remain to be made.
An interest rate that makes the present value Ò à For simple loans, the simple interest rate
of future income (including principal and interest)
equal to the price of an instrument. equals the yield to maturity.
YTM is the most accurate measure of interest
rates.

3. MEASURING INTEREST RATE FORMULA OR PRESENT VALUE (PV)

v PV of an amount
3.3. Yield to maturity: PV0 = FVn / (1+i)n
Ò PV of an ordinary annuity
3.3.2. Yield to maturity of fixed repayment loan:
1− (1 + i)-n
PVA = PMT
i
- EX: the loan is $1000 and the yearly Ò PV of an annuity due
payment is $126 for the next 25 years. Write
the formula to calculate today’s value of the 1− (1 + i)-n
loan? PVAD = PMT (1+ i)
i

YTM OF FIXED REPAYMENT LOAN

EX

PV = pmt/i* x [ 1 – 1/(1+i*)t ] Ò Ms. Hong borrowed 50 million VND from HSBC

Where, and at the end of each year she had to pay
PV: present value 13.19 million VND in 5 years. Calculate
maturity yield (YTM)?
pmt: fixed repayment annually
i*: yield to maturity
t: maturity
 YIELD TO MATURITY OF COUPON BOND:
EX

Ò Mr. Bao buys a car for 500m VND, the payment

method is as follows: Right upon purchase, he
pays 240m dong, the rest is paid by monthly
installments for 5 years. Calculate the monthly
installment amount (pmt), knowing interest rate
of 18%.

3. MEASURING INTEREST RATE

3. VALUATING INTEREST RATE
3.3. Yield to maturity: 3.3. Yield to maturity:
3.3.3. Yield to maturity of coupon bond:
3.3.3. Yield to maturity of coupon bond: C
P = C/i* x [ 1 – 1/(1+i*)t ] + FV/(1+i*)t
Where,
P: price of bond (present value) P = C/i* x [ 1 – 1/(1+i*)t ] + FV/(1+i*)t
Where,
C: coupon P: price of bond (present value)
i*: yield to maturity C: coupon
i*: yield to maturity
t: maturity t: maturity
FV: face value of bond FV: face value of bond

YIELD TO MATURITY OF COUPON BOND YTM OF A COUPON BON

Maturity
Ò A 10-year coupon bond has a par value of 5m VND YTM
1 2 3 4 5 6 7 8 9 10
and norminal interest rate (coupon rate) of 9%.
Ò a. If the buying price is equal to the par value, 8.50% 100.46 100.89 101.28 101.64 101.97 102.28 102.56 102.82 103.06 103.28

what will YTM be? 8.75% 100.23 100.44 100.64 100.81 100.98 101.13 101.27 101.40 101.51 101.62

Ò b. If the purchase price is 4.5 million dong, 9% 100 100 100 100 100 100 100 100 100 100
calculate YTM?
Ò c. If the purchase price is 5.5 million dong, 9.25% 99.77 99.56 99.37 99.19 99.03 98.89 98.75 98.63 98.52 98.41

calculate YTM? 9.50% 99.54 99.13 98.75 98.40 98.08 97.79 97.53 97.28 97.06 96.86

9.75% 99.32 98.69 98.13 97.61 97.14 96.71 96.32 95.96 95.64 95.34
IMPLICATIONS ABOUT YTM, BOND PRICE AND
ITS PAR VALUE PRACTICE

Ò When YTM = idn, Pbond = Par Value Ò Firm A issues ten-year bonds with a par value of
Ò When YTM > idn, Pbond < Par Value USD $1,000 and the coupon rate of 15%. Assuming
the market interest rate is 15%, calculate the bond
Ò When YTM < idn, Pbond > Par Value
price? If after 1 year, the market interest rate drops
to 10%, how much is the bond price? Similarly, if
Ò Bonds have an inverse relationship to interest rates the required rate of return increases to 20%,
calculate the bond price?
Ò As the bond nears its maturity date, the bond
price naturally tends to move closer to par value

PRACTICE 3. VALUATING INTEREST RATE

Ò A 5-year coupon bond is sold at 100m VND, par 3.3. Yield to maturity:
value of the bond is 120 million dong. The 3.3.2. Yield to maturity of coupon bond :
bond’s yield is 10% per year. Calculate the
Ò Perpeptuity:
coupon of this bond.
i* = C/P
Ò Note: nominal rate of bond calculated as follow

i = C/FV

3. MEASURE INTEREST RATE

EX: YIELD TO MATURITY OF ZERO COUPON BOND
3.3. Yield to maturity:
3.3.4. Yield to maturity of zero coupon bond Ò BIDV has issued a 10-year zero-coupon
(discounted bond): bond with par value of $1000. If the investor's
required rate of return is 12%, what is the
FV = P* (1 + i)n selling price of the bond?
Where,
FV: face value of bond
P: discounted price of bond
i*: yield to maturity
n: maturity
MEASURE INTEREST RATE 4. OTHER INTEREST RATE MEASUREMENT METHODS

Ò 3.3.2. Yield to maturity of consol bond

Ò fixed-income bonds without a maturity date and
are also known as perpetual bonds
Ò The equation showing the relationship between
the price and YTM of a consol bond is a special
form of the equation for a coupond bond with
n going to infinity and FV = 0

4.1 CURRENT YIELD 4.2 YIELD ON DISCOUNT BASIS

Ò A frequently used approximation for the yield to Ò Discount yield calculates the investor's percent of
maturity on a long-term bond (often >20 years) return based on the bill's face value.
Ò The current yield is defined as the yearly coupon Ò YTM of 1-year bond:
payment divided by the price of the security. Ò i = (FV – PV)/PV
Ò The current yield and the yield to maturity always Ò Discount yield:
move together.
Ò The current yield is a good estimate of the maturity idb: discount yield
yield when the bond price is approximately equal to PV: price fo discount bond / T-bill
the par value and when the maturity of the bond is
large enough. FV: face value of discound bond / T-bill
n: number of days remaining until the maturity date
of T-bill

5. RATE OF RETURN

Ò A Rate of Return (ROR) is the gain or loss of an Ò The rate of return will be less than the bond's
investment over a certain period of time. current yield when:
Ò A.The selling price of the bond is smaller than its
par value
Ò B.The selling price is greater than its par value
Ò C.The selling price is smaller than the initial
Ò à RET = ic + icg purchasing price
Ò ic: current yield, icg: capital gain Ò D.The selling price is greater than the initial
purchasing price
 PRACTICE – EX 1

Ò The rate of return may be equal to the YTM, but Ò Write an equation to calculate the maturity yield
it may also be different from the YTM of a home loan installment loan agreement.
Knowing that the house price is 600 million
Ò YTM: The percentage rate of return for a bond dong, the customer must immediately pay 30%
assuming that the investor holds the asset until of the value of the house, the rest will be paid in
its maturity date 10 years, each month 5 million dong
installments. The first payment is 1 month from
the time of purchasing? (If the first installment
(pmt) is on purchase, how would your answer
change?)

EX2 EX3

Ò A $1000 5-year coupon bond has a periodic Ò A) A $1000 5-year coupon bond that has a
coupon of $80. The YTM of equivalent bonds coupon rate of 7%. Calculate the price of this
is 8%. bond, knowing that its YTM is 10%
Ò A) Calculate norminal interest rate of the Ò B) An investor buys this bond and sells it right
bond. after receiving the first coupond payment.
Ò B) Calculate the bond price. Calculate the rate of return that the investor
receive, knowing that when selling it off, the
bond’s YTM is 7%.

EX4 EX5

Ò A $1000 3-year coupon bond has a nominal Ò Jessica is in the market for a new car. She has narrowed
her search down to 2 models. Model A costs $27,000
interest rate of 12%. The coupon payment is and Model B costs $18,000. With both cars she plans to
paid every 6 months. Calculate the price of a pay cash and own them for 3 years before trading in for
a new car. Her research indicates that the trade in value
bond knowing that its YTM is 6% for Model A after 3 years is 52% of the initial purchase
price, while the trade in value for Model B is 33%.
Jessica has no emotional attachment to either model
and wants to make a strictly financial decision. The
interest rate is 7%. For simplicity assume that operating
and maintenance costs for the models are identical
every year. Which model is the better decision and how
much "cheaper" is it than the alternative?
EX6 EX7
Ò College tuition has been rising at a rate of 6% per Ò Mr.An purchases a 20-year bond, pays $ 100
year. Currently the average tuition of a state
college is $9,500 per year. Andrea's son Trevor will at t = 1, $ 500 at t = 2, $ 750 at t = 3, and
begin college in 13 years. Andrea's portfolio is fixed payment X at the end of each year for
making 3% annually. How much does Andrea need the remaining 17 years. The bond price is $
to have set aside today/now to pay for 4 years of
college for Trevor? (Note: Tuition will continue to 5,544.87. Similar investments with the same
change annually and Andrea's portfolio balance risk has a return rate of 9%. Find X?
will continue to accrue interest while Trevor is in
school. Also, tuition is due at the beginning of
each year.)

EX8 IMPACT OF INTEREST RATE FORECAST

Ò The 10-year bond pays $ 2,000 at the end of

each year over the next 3 years (t = 1,2,3). Interest rate is
Then, the bond pays fixed amount at the end of Borrow long-term
predicted to
decrease
each year for the next 6 years (t = 4,5,6,7,8,9). loans

When t = 10, the bond matures and pays Borrow short-

term loans
$10,000. The bond price is currently $24,307.85 Interest rate is
predicted to
and its yield to maturity is 7.3%. How much is raise
the fixed amount of the bond payable from year
no.4 to year no.9?
Borrowing decision

14/12/2021

IMPACT OF INTEREST RATE FORECAST

Interest rate is
predicted to
Buy short-term bond decrease

Buy long-term
bond

Interest rate is
predicted to
raise

Investment decision

14/12/2021