Lecture 8: Interest rate vs. other related variables Mishkin chapter 4 – part B Page 79-91
Current yield (iC) Current yield is an approximation to the yield to maturity for coupon bonds.
Current yield Current yield would be a better approximation to yield to maturity if: purchasing price (P) is nearer to the face value (F) maturity is longer Current yield ic and the yield to maturity i always move together in response to changes in the purchase price (P).
Yield on a discount basis (idb)
Yield on a discount basis Discount yield idb understates yield to maturity; longer the maturity, greater is understatement. Discount yield idb and yield to maturity i always move together in response to changes in the purchase price (P).
Rate of return (r) Return = payments + capital gain Rate of return = return/price
Real vs. nominal interest rates Previous interest rates are all nominal interest rate . Real interest rate is adjusted for changes in price level so it more accurately reflects the cost of borrowing.
Interest rate risk For bond holders who would sell the bond someday before maturity: Prices and returns for long-term bonds are more volatile (i.e. higher interest rate risk) than those for shorter-term bonds.
Recap Current yield Yield on a discount basis Rate of return Nominal and real interest rate Interest rate risk Quiz