Slides_Fundamentals of Investments - Chapter 9 pot

9 9 C h a p t e r Interest RatesInterest Rates second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 2 Time is Money © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 3 Interest Rates Our goal in this chapter is to discuss the many different interest rates that are commonly reported in the financial press, as well as their basic determinants and separable components. Goal © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 4 Interest Rate History © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 5 Work the Web  For a look at interest rates from 3000 B.C., visit the historical research section at: http://www.pei-intl.com Money Market Rates 9 - 6 McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 7 Money Market Rates  Prime rate - The basic interest rate on short- term loans that the largest commercial banks charge to their most creditworthy corporate customers.  Bellwether rate - Interest rate that serves as a leader or as a leading indicator of future trends, e.g. inflation.  Federal funds rate - Interest rate that banks charge each other for overnight loans of $1 million or more. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 8 Money Market Rates  Discount rate - The interest rate that the Fed offers to commercial banks for overnight reserve loans.  Call money rate - The interest rate brokerage firms pay for call money loans from banks. This rate is used as the basis for customer rates on margin loans.  Commercial paper - Short-term, unsecured debt issued by the largest corporations. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 9 Money Market Rates  Certificate of deposit (CD) - Large- denomination deposits of $100,000 or more at commercial banks for a specified term.  Banker’s acceptance - A postdated check on which a bank has guaranteed payment. Commonly used to finance international trade transactions.  London Eurodollars - Certificates of deposit denominated in U.S. dollars at commercial banks in London. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 10 Money Market Rates  London Interbank Offered Rate (LIBOR) - Interest rate that international banks charge one another for overnight Eurodollar loans.  U.S. Treasury bill (T-bill) - A short-term U.S. government debt instrument issued by the U.S. Treasury. [...]... McGraw-Hill Companies, Inc All rights reserved 9 - 22 Rates and Yields on Fixed-Income Securities Fixed-income securities include long-term debt contracts from a wide variety of issuers: the U.S government, real estate purchases (mortgage debt), corporations, and municipal governments McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 23 Rates and Yields on Fixed-Income... to maturity has a asked discount of 3.22% For $1 million in face value, asked price = ⎞ ⎛ 170 $1,000,000 × ⎜1 − × 0322 ⎟ = $98 4, 794 ⎝ 360 ⎠ So, on this 170-day investment, you earn $15,206 in interest on an investment of $98 4, 794 , or 1.544% 365/170 = 2.147 So APR = 2.147×1.544% = 3.315% McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 21 Money Market Prices and Rates... term STRIPS stands for Separate Trading of Registered Interest and Principal of Securities McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 29 The Term Structure of Interest Rates McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 30 The Term Structure of Interest Rates An asked yield for a U.S Treasury STRIP is an APR, calculated... Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 32 Nominal versus Real Interest Rates McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 33 Nominal versus Real Interest Rates The Fisher hypothesis asserts that the general level of nominal interest rates follows the general level of inflation According to the Fisher hypothesis, interest rates... average higher than the rate of inflation McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 34 Nominal versus Real Interest Rates McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 35 Traditional Theories of the Term Structure Expectations theory The term structure of interest rates is a reflection of financial market beliefs regarding... plot of Treasury yields against maturities It is fundamental to bond market analysis because it represents the interest rates for default-free lending across the maturity spectrum McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 24 Rates and Yields on Fixed-Income Securities McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 25... by The McGraw-Hill Companies, Inc All rights reserved 9 - 19 Money Market Prices and Rates In general, if we let m be the number of periods in a year, an APR can be converted to an EAR as follows: ⎛ APR ⎞ 1 + EAR = ⎜1 + ⎟ m ⎠ ⎝ McGraw Hill / Irwin m © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 20 Money Market Prices and Rates Example: Prices and Rates Suppose a T-bill with 170... by The McGraw-Hill Companies, Inc All rights reserved 9 - 13 Money Market Prices and Rates Bank discount basis - A method for quoting interest rates on money market instruments Used for T-bills, banker’s acceptances, etc Current price = ⎛ Days to maturity ⎞ Face Value × ⎜1 − × Discount yield ⎟ 360 ⎠ ⎝ McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 14 Money Market.. .9 - 11 Work the Web For the latest on money market rates, visit: http://www.money-rates.com McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 12 Money Market Prices and Rates Pure discount security An interest-bearing asset that makes a single payment of face value at maturity with no payments before maturity... is the number of years to maturity McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 9 - 31 Nominal versus Real Interest Rates Nominal interest rates Interest rates as they are normally observed and quoted, with no adjustment for inflation Real interest rates Interest rates adjusted for the effect of inflation, calculated as the nominal rate less the rate of inflation . corporations. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 9 Money Market Rates  Certificate of deposit (CD) - Large- denomination deposits of $100,000 or more at. 9 9 C h a p t e r Interest RatesInterest Rates second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien . The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 4 Interest Rate History © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 9 - 5 Work