1. Future Value, Present Value and Interest Rates
Chapter 4
Future Value, Present Value and Interest Rates

2. Bond: A promise to make a series of payments on specific future date
Bond Price = Present Value of payments
Bond Basics

3. $1000 Face Value 50-yr, 3½% coupon bond issued on May 1, 1945.
Coupons
Coupon Bond

4. Coupon Bond A type of loan:
Interest paid during the life of the loan
Loan repaid at maturity
Coupon Rate: the annual interest the borrower pays (ic)
Maturity Date: when the payments stop and the loan is repaid (n)
Principal: the final payment (F)
Coupon Bond

5. Coupon Bond: Valuing the Principal
Present value of Bond Principal = Payment divided by one plus the interest rate raised to n
Coupon Bond: Valuing the Principal

6. Coupon Bond: Valuing the Coupon Payments
Value of Coupon Payments = Present value of the sequence
Note that C= ic x F
Coupon Bond: Valuing the Coupon Payments

7. Price of Coupon Bond: Principal + Coupons
Price of Coupon Bond (PCB) = Present value of Coupon Payments (PCP) + Present Value of the Principal (PBP)
Price of Coupon Bond: Principal + Coupons

8. Bond Pricing: Important Property
The price of a bond (PCB) and the interest rate (i) are inversely related:
i  PCB 
Bond Pricing: Important Property

9. Credit cards are useful.
But lenders charge high interest rates.
Pay off your balance as fast as you can.

10. Real and Nominal Interest Rates
Borrowers care about the resources required to repay.
Lenders care about the purchasing power of the payments they received.
Neither cares solely about the number of dollars, they care about what the dollars buy.
Real and Nominal Interest Rates

11. Real and Nominal Interest Rates
Nominal Interest Rates (i) Interest Rates expressed in current dollar terms. Real Interest Rates (r) Nominal Interest Rate adjusted for inflation.
Real and Nominal Interest Rates

12. Real and Nominal Interest Rates
Nominal interest rate = Real Interest Rate + Expected Inflation i = r + e (This is called the “Fisher Equation”)
Real and Nominal Interest Rates

13. Real and Nominal Interest Rates
Countries with high nominal interest rates have high inflation:
  i

14. HWs: Page 91, 1 -5, 7, 10, 17, 20