DV Tek kk eee elle eels de In the maspet thee cows be more than one vote for any. Particular forward wide period. For example, the forward rose for borrewing may. liffer from that for tending. Thu, when discussing markeh rades one must be specific. However, in thearis- cal discussions the definition of foruard wases is based on an - Leeder ina, act of spot vadey. (WhicR is themselves gererly represent ickalizations or Guermages of market conditions.) there calculated forward vases are ofter) termed implied -orwrd rate, +o distinguish them from marbet forward “robe. We roy wile spot vate by using, forward rot notatien.as fallour: +, tne fF ‘om: 4, 3h, wai, BF aa or ee ” = om " a. Oo os & 4 a 2 * Se °F Scanned with CamScannerTerm Structure Exblanations: - - s ee ed Ce £ Tn general, Fin the ytd amve,: slopes gradubly, uproard as wabertyg inewaxs. The curve. 's alms! yemer never filet. = &, Ore can observe thot the sot vale curve Rot -similoer Paracton istics. S&S 2 Now th it natural to ach. sf there a simple expenation for this Ss typical. shape. bohy 5 the cume “not gust flat af a common inleredt ge » vate 2. . There are three standard explanations er theovig for the i structure, Cid Exbectations Theory :- See the book page no 81. (2) “Liquidity Preference \- See the book. page no. 82. (2) Meerpet Seeaatial '= Sea. the ‘book page no. $2. Eppectatrons Danemieste From the expectations theory , the shape of the spot rate curve cari be developed into a ue ful tod din JAs own wight. This +004 can be ued +0 form a plausible forecast of fatur interest yas. bot Rote Forecasts: ~ he basis of this method st to auume that Se the exbeatations Tahu by the cunvent shot rade curve wit ac be fulfilled . Umobr this axumbhon we can then ‘ next yoor's spot vate curve from the curremt one. This new curve implis get anotter 4b of expectations for, the folowing, year, PPP PPPLD PP PPP PPP PANN NM HH Scanned with CamScannera a Of we assume trot these , toe, ave fulfilled, we can proctict ahead once, ages. Going forward inde this way, an entire future of spot vate curves can be prechicted. Suppose current pote vale cee is: 3) > $2, Sy2-°* >» Su andl subpox nexd eons spol vate curve : 4)’, 3), 33,--- 1 £na. then we Rare to determine By ti ye.) Bay The current forward vote fig can be ‘vegraded a the expectotray ef whet the interest “ie ui be next year. In otherwords , tay is next yor! spot vate +7), thad is, see = fig. As we pmow that the forward vate ti: Veal ra {= {G82 tr (ise Je | J (34 4 {= (sr) a) Cl&reny. uy 1H, L T SA 1455 | _ Bos aE A [eet] “te fs (14740). Thus is the basic formula for Ubdating, a spol vote curve unckr the ayumption that expectations are FH fulfivled. Starting with the current curve , we obtain an estimate of next ert ce, We term tus transformation exbectatons ely nomics, since st gives am explicit Ravacterizasion of the dy rasmies of the spot vates curve boyd om the exbectations assumbhon . Scanned with CamScannerExample 4:5!- G4 ut tobe »spel ved. cure 04 follows: crea |e 45 | 4 | 40 ac se | [ferent [G00 | 6-45] 6.60 | F10] 36 | #56 + | Then we caluwleds f the forecat for next yeaw's spole vrat< carve under expectah'ons a oO foUour: t Ith, 4 fir, - [Go % 1 064-5)™ = i —1. = 6.0690 3 44 ais. = [a | i 7 M43) 1, aye 0690, -(¢ mdi | —1] 30.0420 7 Yi shed, = [Ome > ut 45 - y % La { OpIs = [ese] —l = OOFE 0.0744 1 fox ' (+45) Satie = (= ] = 14S, N, ()-6 #30)° i 7 106 = 0:073,0 ——————E——— ee Scanned with CamScanner PPPFIHHSASSSS PPP PLL. Pf LPPPPLPOLLPPLPLLs coy t (14% a Ss oie fis = [ee | - s 3 : 6% ® 7 [oJ =| = 0.070% ® nm 7 y, B Plast ye 3 ~ 1+, at 3 Ve > : ao ’ = [ee ] =I = 0.0907 +O s 5S Now, we Rewe the fdlouwrng table. > 7 s , | 4, 4 4, | 44 | Ss su | sy Db buvrent G00 | 645 $0 | Zo | 4:36 | #36 + 7 Prncost iE Flo | B44) 4:70 | 4-47-| goog » £ AAL futue shot rate cunes implied by an initrd shot vote curve. r p can be diplayed by Listing all of the forward wah ayou‘ated uty mitial spol rote curve. We can List tt 04 follsus’ tiv a ‘tian geo : array: : font feet toa - ae fe fon > fa he ha fer, tun fy fue fue eneeeiee fan - , Frnt ,0-1 freayn fe foam Scanned with CamScannerDiscount Faccows:- In tus Sechon we UU see how Yo calcy-C date discamt factor behueen hwo Himes. We will Use « double index system to the discount factors pavatleling. the, spin used for forward vodes, Accardlingly , the syne dyn denote the chiscour factors used to discount cash received! ad time back ts Gn equivalent amound of cash of te J. See the following cbiagram. Axe dloyy, Formals: g .—! . = THR | Oye = LN oe eo ” 44 Oye: AAP (fe PPP PP PPP PPP PDPD ID OHH 9 948 8 Scanned with CamScannerTTT TT TVS YY TY OUVOOUGOCOOOCUSGE4EES Discount factor redotion,- The clitcount factor between periads 1 avd eee Jt olfimed an ( Og = (+ hea jie these factors sadisfig the compounding rule : deg = Ay Spe for UC aee. Short Rates:- SRorl rate gre the forward rates shaeing a single time peried. that means the short yale at Hme Kis a= to? thet 2, at ts the forward vote fron k to KH. The spot rade &, 1s found from the short rales from the fact thar inferest earned from time ze te Hme & is identical | to the imfeest that wowd be earned by rolling. ouer am | investment eae year: Shecificady,, Li ge ai ae Dera ane Kk 7 a Net Fos wt = Fei i (44), > (14% dla) -- » C4%).—_ ap 2 W) “ ° 1 ie 3 Gee. (1476) 4 Gores Noasraen + bare Vrer\) Wy bested Cnr) bons) loer). Scanned with CamScannerWe brow that 4 =f, thenfon equation @) beannes OK (14 bx) = llvve)(isn (ery -- (3) E Now betwerm pervads 1 and i, we can waite: ae Sky = fire ° ar K / coe kaw SR. KI (Mh) = brnterg-- Gore) Sane iaso tote ines ace ce iy) Ho Fivally behween periods 1 and J) we can write. de (i+ fig ) = Ere C4 %) bn ). (4%). Heme the shail rales form a convenient bass for gereroting all other arades . . 2 The short vale ane especially. 4 peaseng Jn the entext of expectations Olyrams , becouse they alo not Pane from year do year: die can ~mape Pllnaing: fortes} Kovwe HW My yee Hy ny a a i % TR Yr YS % +. my Tha, Sr M4 Yeo Yn 4 Scanned with CamScanner PPPIPPP INO DTIING PPPPPPP PPP PPP PPP PPPSExample: J SPork vader: 6.00 6-90 450 $00 940 g.60 9-00 6-90 FSO $00 3-40 $60 9-00 FSe Bob $40 Bbo 9.00 Goo 40 Sr bo 3:00 $40 gbo 9-00 &bo 4-00 g-u : Firnward Rates’ Gurvent: 6-00 & 45 6 Bo Flo F396 FSG HF Ned yeor 690 #20 FOF FO Fe B06 y For next eon: (i445 y har fis = (ty al — teste? 1 2 pose ae les] [sor (oni 7 (i: 0645 J* 0.0 #45 ee " te ay Scanned with CamScannerg, = [ot] 25 (145.92 [reno 7 = ems =! = 0.079} ee L453" es = vit 0750)" i: l= BH 0.0812 ebay (+6 } fig = [Seay - i = peas a os 6+ 6330. Jo easy ae [ ry | 1453) | | 5 G-s1ey" -l = $4 0-060 (1. 0680) 3 (ivsey? 9/84 b+s3) A = { "5 = [re Vn. peers eatery? Scanned with CamScanner PPPPP PPP PEP PPL PP PPP PPPPPPPITGI ITI S5SVU YY SY YY EV UEYUUUUEEEOOEOOOOG4OGbGES ec ee cg ee 145¢ y‘ ““ ae fy 7 1453 )> uv bah (0456) “lo = 00433 (i068 )> foo 4 yeow Yes £ Cts)" r - agp = ra] droga YP 0gse = ae, | -| = Oe oe te EI (t34)* n 7 [Ga] -1 = 6-084 (howte)* fsa)’ a faye = Gras bah = eee 1 = 0.0850 (i oF) * (iva JP Yt tm = Epps 1 oad” yo (roHe) + 0-086R n Scanned with CamScanner —Gse) ces - [Gy ‘6 ao 0:0860 - 07s) at h 07#36)% area Si ee 4 45a) * Woes bo Pome) - (i0943)* he = 00860 1.07 26 )8 7 Prom 6 yew: f dis sayt on oe = en] Cae =| = 6:0900. Trenefre final feces i 600 6-45 6. fo FO HSL BSL By 6-90 #10 24 PHO FH HOG F50 795 #9R BIL $3e 4:00 f20 833 bse 3-40 $50 hp 3.60 3-B0 9.00 Discount Fac ton: « db, a a “a = 0943, (+4) Scanned with CamScanner PPPPPPPP DP PPPPPPPPPPPPPPPIINIS HSSVUEV VV UV VU VCYVUUUUUOUEUUUTOUOUUUUSECEES ! dc =: « = 0.963 or = (4? (1- 0645)" d ! = lL = og a3 Ti haa)? [reuse ! _ I a OFbe doa = tie 7 Cone) ! Jens ! a Le OPI Tey? Coe es es i (= 064% a+ five y (: #56) l = | = 0592 S45 Ti = [heat —-— = 0-935 da = Pil = 1.9640 ! ms ! = 0-Bpo ee [i-e422 l = 0:%06 Ing = = (034% 3 7 iin ) J | J on = = 0-793 1S (ots J (074 * ik i te eet Ae Gas” Gon? I ! = 0.628 ayy = i+ tua) . (Hrapely ¢ & a = 0-930 aL Ct bys tists Scanned with CamScannera = ! — dy ge (8,9 = OBlf (-0798)" dg = ct = lL. | 2 omes * (ty (10492)? d. es ! eee ne =n 2 Cra ~ Cosi S10 7 ae =) lL a te l= 06H a (ge Getsey ° Chores 3, SLE oy ogee / {i+ fe J ) 0600 J t FS ! es : eS Cee?” Co =O ao _ 5%. Ue? Gating 4g = lL ww a = oan (+64) (19880) 4 ee = 445 (ty 5 yr Fo9te 0-923, bee I _ 4 Gap” ices, te ee J, = —t = —! = 0-795 a (6 tig ht (1-096%)> | ds, I Caf Goetley © 87% Scanned with CamScanner PAPRAPDPDPPPPPPPPPPPPPPPPIDSSIHSSSS,COOVOHOVVOOUVEUUVOUOEEUEECLEDEEZEEE SS a. gi il =e aloe 0-948 Tago * Tretiyt dee a tS pe = 091 ae Ft = = (3) boge Therefore fival forecost for_durcount factor_i¢: 0-943 6:883 6-92) 0-460 opel 06tG 0-592 0:935 O-bfo 0-806 0-743 0.68 0.628 0: 930 0-$61 0-495 0732 OOH 0-926 0-954 O-Fb4 0: FLL 0-923 0-849 0-349 0:92) 0-$45 0: GIF Tnvaniance Theorom:— Suppose that interest yates evolve xcording. Eee : to expectatrons dynomics. Then Casum ing a yearly compounding Gonvemton ) @ sum of money investeol in the smienegt vate marpeb for 0 years ui grow by a factor of tty )” idependent of the invetment and ye rmvestment shatega. (0 dong 4 at) funds are fg iuested ). Running Present Value. The presemt value ofa cash ftow sheam eo is easily caletelotel in the term structure from work, One simply multiplies eack cash flowt by the discount factor axtociased! with the periool of the flow and then sums these Aiscxrsntec! values. We will use abevrahve way to arrange, the calculations of Py. Scanned with CamScannerWe uu calewlode present value in a yecursie nanne startin auth the final cash foo and tuoy ping backward to the resent. this method usea the concepts of expectahons dynamics. Suppose (%8, % yA, - +, Am) & A cash flow stream then resent value of tht cash flow stream ty de o¢ Hme © 2 denoleol by Pye) and PVC) = Mobo Mm dh + Mydyt-- + tb ndnn = Fo + doy + dor tMydogt-- + Indo. ©O After 1 yp cerae cash (tow stream fy Sime =) %mJ ard bresond value is PV) = WF Md +I He -- + MAW, @ Stools after Kt bervod , vemaing cash How strcam ig be > Mera Mey 2%) Ano present value i PVA) = Met Met eee * Mer eet” +, &. As we know that for 7294 6K, we dey. = 67 Ie, Thenefore equation GT con be written a4 PVC) = Yo % (aon) 4% (Aor dn) 4% (nn >= Loy tn) It Oo +401 + Me Ahi 4 dys +-- +e nel) il tp +d. PY) from @ Scanned with CamScanner NN PPPPPPPPPRPLPISSSISISS uoepheppeere?60% VPEVVUOUVVUFOHUUYUUURYUOOOCOUGGCO4GEY Therefore we fave Pv(o) = %o + don PY Simidanty, equation @) can be written o fous PY(ky = % +, Seren Xeon Hees Feat wer? Gers Fe reay’ Fe et est +b dee Sein © We + dees | Meet Terr Die rs Meas Dre jserg Mm Aes on) | W MA Au, ten” Pv es) 9 ry} Ue HD reat PY (cH! ) TRis equation states that the present value of Hme jo is the sum of the current cash flow and a one -pevied cbscount of next present value . freon Present volue obdalrng - The running present value, sadist. ee the recursion pPv(k) = y+ Ay an py (Kat J » wRere d = —t is Re discount factor for the shovt yate ee 14 Few ot K. Under Hus proce we fint calulote Py0ny, which 1. Yn, that a, Pv(n) = am Ls PyGrd) = Fn F Anan PVC) Scanned with CamScannerthee PV Gr) = Any yg on = U4 UH pion ; ard ten PVG) = Yan +d J Yona Yn nes som +n ob, Py Gs) 0-2,04 ng + Smash ( %a +% Inayn) ., nA MD = Tyg Onn Foams + GIs ay 5 and $0 forth until YQ) 16 found. Example 4:6 (Comlant wuering rate): Suppose Hnal spot vate eeurut tk fob, wth 457 for aU ka42)3,---. 0. Ld orth) = ym) be a cash flow stream. Find the PY. of this cash How sheam, *S We Rave given, Gey MMI) fo cash How stream, Spot vate cen is flat with 4, <1 pH KEG, This implig forward vole is aho equal te y. Now, we calcwate the present value of the cash flow steam o follow Py() = Py) = fy) = pviv-r) = Ins + 1 PVG), any + a! . Pvt) (ha. Yo te PVO) fey Wy + My Noy + Fina soot f vo) Scanned with CamScanner PPPPPPPPPDDPRBRADIAS: PPPPPPPP PPP PPPPOOVWOHOOEOHHLULUOEEEECEEC EEE EG ESS PVG) = ag Le Om t Lam) Wham = gn + Le (Ma + ha ™") Ione = na + ee + 1. %& (ery Simmbonty, Vin-3)\ = de te Eee p (r-3) Yona, + = Toa * Geen * Gary? 0 Pv(o}= %t Liu ttl mae. Lb % Ye tot hat mts dat Example +4 (General wumirg—) We fave the following table: years o ) | 2 \ 3 is \ 5 [ e |# Do Io Cost flo 90 26 | 30 3S to 30 4 g loses | 0-938 | o3 0.926 | 0-923 | O-921 | O-9rF is coun ; “96 | 192-n0 | 120-64 | 92-49 | 56-94] 29.1% | Joo pte) [6898 fl? | ed Given that qp=20, %=25,%=3S, %=35, %= 40, = 30, Fe 320, %='0- doy = 0:993, yg = 0-998, Jag = O°-930) yg = O86, dy = 0%, Jen > 09, dey = Ni We foe to cUewade the yuna ng. present value of tis cach flow strtam. Scanned with CamScannerPVA) = |d PIR) = WOK NeW NH = ASAE VON A Ber sks PUG ) = He + dy, @% Put) = Jot OUNFXK(O = 9g-% PvG) % + de: PVG) W = 30+ 0921 X 29-51% = 56-9R PY) = % +g. PUGS) = 4O + 0-923 % 56-8R = 92.99. Pv@) = 454 d,. Pvay = BS+ 0926 K 92:99 = 120.64 fV@) = % + As. PVG) => 30+ 0-930 K J90-44 = 192-20 pul] = %+%n- PYG) = 25 + 0-935 KX [4b2o0 = 154.96 PU(C} = Xt don PYCIY = 20+ 0993 X ISF-96 PVG) = 166-95] 15 the PV of the cash How stream, Scanned with CamScanner ADADADDDPDA PPP PPP PPP PPP PPPPPIPIP INSVUVVVVUVUVUTHUUUYUYVUUUOEUOOCOUOKOO4GGEES FAoating Rote Gonda! - fh Hoating rode note or bond Bor a ee: fixed face value ard fred masonite bud 44s coupon bayrmonts are fied to curert (short) yote of interest. Por txample: Consider 4 floaiing vote bond thas males coupon Poymonts every G-monfts, LiRon the bond i ives! , the coubn vote for the fized first 6 months is ec equal to the current 6-month interest vate. AL the end of 6-months 3 couhon Payment at that yale ts paid.amd coupon ts = Curent vate y Face Vakue of the bond. 7 2 After ths payment, the vale it aeack: the vade for tre next b-menths 8 ad equal to the cunont ¢- month (thort ) vate. the proces coninucer unt unt until vcd vt. Theorem: ( Footing wrote value):~ The value of a Hosting vole bond 5 equol to par oF amy reat point. "Scanned with CamScanner