Time Value of Money and Bond Market

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.
.
.

(Time value of

(Present & Future Value)

money)
$100

$100

.. (Future Value, FV)

The formula for FV can be written as:

FV = C0(1 + r)T
Where: - C0 is cash flow today (time zero)
- r is the appropriate interest rate
- T or n is the T or n years

5.1

..

(Present Value, PV)

if get F in n years,
what is that worth today?

PV =

(1+ i)n

example

receive $100 in 3 years, i = 5%

what is PV?

PV =

$100

$86.36

(1+ .05)3

Graphic 5.1 The Relationship between Present Value and Interest Rate

...The

Fisher Effect

The Fisher Effect defines the relationship

between real rates, nominal rates and inflation
(1 + R) = (1 + r)(1 + h), where
R = nominal rate
r = real rate
h = expected inflation rate

Approximation
R=r+h

The factors that affect interest rate

Change in
factor

Change in
interest

Economic

increase

increase

Inflation

increase

increase

Money supply

increase

decrease

Government budget deficit

increase

increase

Net flows of foreign funds

increase

decrease

Factor

. .
Bond

supply

bond issuers/ borrowers

look at Qs as a function of price, yield
lower bond prices
higher bond yields
more expensive to borrow
higher Qs of bonds
so bond supply slopes up with price

10

Shifts in bond supply

11

Qs

12

(shift rt.)

13

(real cost of borrowing)

(shift rt.)

14

. .
(Bond

Bond
yield

Qd of
bonds

price
of bond

Qd of
bonds

demand)

so bond demand slopes down with respect to price

15

16

D
D
Qd

17

(shift left)

18

(shift left)

19

(shift left)

(liquidity of bonds)

(shift right)

20

. .

Bond market equilibrium

21

 Fisher effect

--

(real return)

--

--

(real cost )

22

Fisher effect

23

(economic slowdown)

24

. .
Bond risky

(Default risk/ Credit risk)

25

(Inflation risk)

(real value of these payments)

26

(Interest rate risk)

/price)

(value

27