1 . If the market interest rate is above an individual's personal discount rate-We would expect that individual to save.

standard deviation and value at risk -Standard deviation reflects the spread of possible outcomes where value at risk focuses on the value of the worst outcome. If a saver is willing to wait a year to receive a $100 payment rather than accept a lesser amount today-The present value must be less than $100 The coupon rate for a coupon bond is equal to-The annual coupon payment divided by the face value of the bond If the internal rate of return from an investment is more than the opportunity cost of funds-make investment price of a bond-Taking the present value of all of the bond's payments. Leverage increases risk. The variable rate mortgage may be more attractive when The lender expects inflation to increase. High rates of inflation-High nominal interest rates and positive real interest rates. A basis point-one-one hundredth of one percent. nd 2 . Zero cupon bond-promises a single future payment. Price of treasury bill 100 face val 100/(1+i)^n Price of coupon bond- present val of face val +present val of cupon payments Price of bond above face val-yield to mat is mellow coupon rate. If bond price= face val cupon rate=yield to mat, =current yield Holding period return-curent yield+capital gain Bond price increase-quantity of supply increase Supply of bonds exceed demand bond price fall yield rise Increase in nation wealth-bond demand shift right Interest rate expected to rise-bond price fall demand for bond decrease Default risk-not making payment Commercial paper-unsecure short term debt Risk structure of interest rate- interest rate with same maturity Expectation hypothese-slope depends on future short term rates. Chapter 4. To calculate future value we multiply the present value by the interest rate and add that amount of interest to the present value `higher the interest rate (or the amount invested) the higher the future value `future value =multiply the present value by one plus the interest rate raised to a power `Fractions of percentage points are called basis points `Doubling the future value of the payment without changing the time involved or the interest rate, results in a doubling of the present value `The sooner a payment is to be made the more it is worth

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`Higher interest rates are associated with lower present values no matter what the size or timing of the payment `At any fixed interest rate, an increase in the time until a payment is made reduces its present value. `The further in the future the promised payment is to be made, the more the present value falls (interest rates) People with a low rate are more likely to save, people with a high rate are more likely to borrow. (internal rate of return) investment will be profitable if its internal rate of return exceeds the cost of borrowing. (bonds) A bond is a promise to make a series of payments on specific future dates `Coupon bond, which makes annual payments called coupon payments `The price of a bond is the present value of its payments. `Value of the coupon bond rises when the yearly coupon payments rise and when the interest rate falls (real and nominal inters rates) real interest rate, which is the inflation-adjusted interest rate `Fisher equation = nominal interest rate is equal to the real interest rate plus the expected rate of inflation. Chapter 5 (Risk) Risk is a measure of uncertainty about the future payoff to an investment `Risk can be quantified. Risk arises from uncertainty about the future. Risk must be measured relative to some benchmark. `We measure risk by measuring the spread among an investments possible outcomes. Variance and Standard Deviation. `Measure the risk of alternative investments. Value at risk measures risk at the maximum potential loss. (probability) Probability is a measure of the likelihood that an event will occur. `Investment payoffs are usually discussed in percentage returns instead of in dollar amounts. `A wider payoff range indicates more risk. (Hedge risk) making two investments with opposing risks. (Spreading risk) independent sources of risk lower your overall risk. Chapter 6 (Bond prices) zero-coupon bonds, which promise a single future payment. `Coupon bonds, which make periodic interest payments and repay the principal at maturity. (zero coupon bonds) Sell at a price below their face value. Difference between the selling price and the face value represents the interest on the bond. `Shorter the time until the payment is made the higher the price of the bond. (Fixed Payment Loan) Home mortgages and car loans are examples of fixed payment loans, fixed number of equal payments. `Amortized- borrower pays off the principal along with the interest over the life of the loan. (Coupon Bonds) present value of the periodic interest payments plus the present value of the principal repayment at maturity. `Consols-only periodic interest payments, borrower never repays the principal. Government only. (Bond Yield) yield to maturity-yield bondholders receive if they hold the bond to its maturity.

`If yield to maturity equals the coupon rate, the price of the bond = face value. If the yield is greater than the coupon rate, the price is lower; if the yield is below the coupon rate, the price is greater. `If you buy a bond at a price less than its face value you will receive its interest and a capital gain, which is the difference between the price and the face value. `When the price is above the face value, the bondholder incurs a capital loss and the bonds yield to maturity falls below its coupon rate. (Current Yield) It is the yearly coupon payment divided by the price. `Current yield moves inversely to the price; if price is above the face value, the current yield falls below the coupon rate. If the price falls below the face value, the current yield rises above the coupon rate. If the price and the face value are equal the current yield and the coupon rate are equal. `When the bond price is less than its face value the yield to maturity is higher than the current yield, and if the price is greater than face value, the yield to maturity is lower than the current yield, which is lower than the coupon rate. (Bond Supply) Bond supply curve is upward sloping; the higher the price of a bond, the larger the supply. `Bond demand curve is the relationship between the price and quantity of bonds `Bond demand curve slopes down; as the price falls, the reward for holding the bond. `If the price is too high= excess supply of bonds will push the price back down. If price is too low = excess demand for bonds will push it up. (Shift Bond) Changes in government borrowing: the more governments borrow the greater the supply of bonds, shifting the curve to the right. `Changes in business conditions: business expansions mean more investment opportunities, increasing the supply of bonds. Weak economic growth can lead to rising bond prices and lower interest rates. `If inflation is expected to increase then the real cost falls and the desire to borrow rises, bond supply curve shifting to the right. (Bond Demand) Increases in wealth shift the demand for bonds to the right. `Fall in expected inflation will shift the demand for bonds to the right. `If the return on bonds rises relative to the return on alternative investments, the demand for bonds will shift to the right. `If interest rates are expected to fall, then bond prices are expected to rise, and the demand for bonds shifts to the right. Interest rates tend to fall in recessions, so bond prices are likely to increase. (Inflation) An increase in expected inflation shifts bond supply to the right and bond demand to the left, resulting in a lower bond price and a higher interest rate. ` Nominal interest rate will be equal to the real interest rate plus the expected inflation rate plus the compensation for inflation risk.