“Green Nudge”

“Green Nudge”
• The U.S. produced around 32 million metric
tons of plastic waste in 2018. The
environmental organization Greenpeace
estimated that number grew to 51 million
metric tons by 2021.

• In China, where delivery is cheap, more than

half a billion people use food delivery apps,
according to German data platform Statista.

• China produced more than 80 million metric

tons of plastic waste in 2021, up by roughly
30% from 2018, according to China’s
National Bureau of Statistics.

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“Green Nudge”
• How to cope with the mountains of plastic waste produced in the pursuit of
culinary convenience is a tough problem faced by governments.

• A recent study suggests a potential solution: the behavioral nudge.

• Rather than ordering people to act a certain way, limiting their choices or
using monetary incentives to in uence them, nudges seek to change
decisions by altering the way choices are presented.

• “People generally prefer to be empowered rather than simply being told what
to do,” said Albert Park, professor of economics at the HKUST, one of the
authors of the study published on Science.

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“Green Nudge”
• The app’s default interface gives users
the option of forgoing plastic cutlery,
but only during checkout and low
down on the screen.

• Starting in 2019, users in three major

cities are presented with a pop-out
window that lists “no cutlery” as the
default option, forcing users who want
cutlery to select the number of sets.

• Those who choose to do without

plastic cutlery are given points that can
be used to fund the planting of a tree.

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“Green Nudge”
• For their study, the researchers examined data collected from 200,000
randomly sampled users in 2019 and 2020 by Ele.me.

• No-cutlery orders increased “signi cantly” (648 percent) after the app change.
The “nudges” didn’t harm business performance or the total number of orders.

• Users in those cities were 20% less likely to ask for single-use cutlery with
their order over the period of the study.

• Women, people over age 24 and infrequent app users were more likely to
respond to the nudges.

• People with more expensive cellphones or who bought more expensive meals
responded more often.

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“Green Nudge”
• About 11% of users were “nudge de ers” who had previously opted for no
cutlery but then chose to get cutlery after viewing the new pop-up message.

• It wasn’t possible to track whether restaurants consistently complied with

users’ decisions to forgo cutlery.

• The study also notes that roughly 80% of plastic waste generated by Chinese
food delivery comes from packaging rather than cutlery.

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“Green Nudge”
• Over 27 months of study, the researchers write, the nudges cut the number of
cutlery sets delivered by 225.33 million, preventing 4,506.52 metric tons of
waste and saving the equivalent of 56,333 trees.

• Applied across the country, it could save nearly 22 billion sets of single-use
cutlery every year, equal to a more than 6% reduction in total municipal plastic
waste.

• Evidence is mixed as to how e ective nudging is as a solution to societal

problems, but the gentle approach proved e ective in this instance.

• “Reducing single-use cutlery with green nudges: Evidence from China’s food-
delivery industry”: https://www.science.org/doi/10.1126/science.add9884

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Is “Nudging” Really Enough?
• Behavioral economists hope to construct
“nudges” that push us in a more
responsible direction.

• They do this primarily by tweaking our

decision-making environment, altering
the way we perceive our options.

• For instance, studies show that placing

fruit at eye level in a school cafeteria can
dramatically increase sales.

• Instead of gorging on cookies, the kids

are nudged into eating apples.

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Is “Nudging” Really Enough?
• In recent years, politicians have begun proposing policies directly inspired by
this conception of human nature.

• But initial results of many of these policies have been humbling.

• Example 1: New regulations in New York City requiring restaurants to list the
calorie content of all menu items.

• Example 2: A recent study in Sacramento, Calif., that tried to curb household

electricity consumption.

• “It’s never easy to apply the latest theory of human nature to actual human
beings. Just because we have a better understanding of how the mind works
doesn’t mean we can always get it to work the way we want.”

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Chapter 6
Valuing Bonds Ch7

Ziwei Wang
Wuhan University
Bond (债券) Terminology
• The bond certi cate describes the amounts and dates of all payments to be
made. The nal repayment date is called the maturity date of the bond, while
the time remaining until the repayment date is called the term of the bond.

• The promised interest payments are called coupons, which is computed

based on the principal (or face value) of a bond. Usually, the face value is
repaid at maturity.

• The amount of each coupon payment is determined by the coupon rate of the
bond. By convention, the coupon rate is expressed as an APR, so the amount
of each coupon payment, CPN, is
Coupon Rate × Face Value
CPN = .
Number of Coupon Payments per Year

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Internal Rate of Return
• In some situations, you know the present value and cash ows of an

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investment opportunity but you do not know the interest rate that equates
them.

• This interest rate is called the internal rate of return (IRR), defined as the
interest rate that sets the net present value of the cash flows equal to zero.

• For example, suppose that you have an investment opportunity that requires a
$1000 investment today and will have a $2000 payo in six years.

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• The IRR of this investment can be computed as
2000
NPV = − 1000 + = 0 ⇒ r = 12.25 % .
(1 + r)6
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Zero-Coupon Bonds
• Zero-coupon bond is a type of bond that does not make coupon payments (e.g.
U.S. Treasury bills). They are also called pure discount bonds.

• The IRR of an investment in a bond is called the yield to maturity (YTM): It is the
discount rate that sets the present value of the promised bond payments equal to
the current market price of the bond.

• Therefore, the YTM for a zero-coupon bond with n periods to maturity, current
price P, and face value FV solves
FV
P= .
(1 + YTMn)n
• If the zero-coupon bond is risk-free, then rn = YTMn.
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 Some financial professionals also use the
term spot interest rates to refer to these
Zero-Coupon Bonds default-free, zero-coupon yields.

Problem (Example 6.1 in textbook)

Suppose the following zero-coupon bonds are trading at the prices shown
below per $100 face value. Determine the corresponding spot interest rates (i.e.
default-free, zero-coupon yields) that determine the zero coupon yield curve.

Maturity 1 Year 2 Years 3 Years 4 Years

Price $96.62 $92.45 $87.63 $83.06

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Negative Bond Yields
• On December 9, 2008, in the midst of
one of the worst nancial crises in
history, the unthinkable happened:
For the rst time since the Great
Depression, U.S. Treasury Bills
traded at a negative yield.

• It means a zero-coupon bond would

sell for a price higher than its face
value. You are losing money by
investing!

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Coupon Bonds
• Like zero-coupon bonds, coupon bonds pay investors their face value at
maturity. In addition, these bonds make regular coupon interest payments
(e.g. U.S. Treasury notes and Treasury bonds).

• The YTM now is the single discount rate that equates the present value of the
bond’s remaining cash ows to its current price:

( )
1 1 FV
P = CPN × 1− + .
y (1 + y)N (1 + y) N

• Be careful: y is di erent from what YTMN means. (Think about why.)

• Also be careful: The YTM is usually stated after converting y into an APR.
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Coupon Bonds
Problem (Example 6.3 and 6.4 in textbook)

Consider the ve-year, $1000 bond with a 5% coupon rate and semiannual
coupons. If this bond is currently trading for a price of $957.35, what is the
bond’s yield to maturity?

Suppose you are told that its yield to maturity has increased to 6.30%
(expressed as an APR with semiannual compounding). What price is the bond
trading for now?

Takeaway: Bond price and bond yield are convertible.

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Discounts and Premiums
• Coupon bonds may be traded at a discount, at a premium, or at par.

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Discounts and Premiums
Problem (Example 6.5 in textbook)

Consider three 30-year bonds with annual coupon payments. One bond has a
10% coupon rate, one has a 5% coupon rate, and one has a 3% coupon rate. If
the yield to maturity of each bond is 5%, what is the price of each bond per
$100 face value? Which bond trades at a premium, which trades at a discount,
and which trades at par?

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Time and Bond Prices
• Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity
of 5%. For a face value of $100, the bond will initially trade for
100
= 23.14
1.0530
• After ve years, if the bond’s yield to maturity remains at 5%, the bond price
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in ve years will be
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100
= 29.53
1.0525
• If you sell the bond after five years, what is the IRR of your investment?
23.14=29.53/[(1+IRR)^5]
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Time and Bond Prices
• Two takeaways from this calculation:
• First, If a bond’s yield to maturity has not changed, then the IRR of an
investment in the bond equals its YTM even if you sell the bond early.

• Second, the price of the bond becomes closer to its face value as time goes
by.

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Time and Bond Prices

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Interest Rate Changes
• In a competitive market, we have rn = YTMn. But rn uctuates with the
economy, which leads to uctuations of bond prices.

• A higher yield to maturity implies a higher discount rate for a bond’s remaining
cash ows, reducing their present value and hence the bond’s price.

• Therefore, as interest rates and bond yields rise, bond prices will fall, and vice
versa.

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Interest Rate Changes

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Pricing a Coupon Bond Using YTMn
• Suppose we know the yield to maturities of zero-coupon bonds
YTM1, YTM2, …
• What is the fair price of a coupon bond with face value FV, matures in n
years, and pays a coupon of CPN annually?
CPN CPN CPN + FV
P= + + ⋯ + .
1 + YTM1 (1 + YTM2) 2 (1 + YTMn)n

• We can then use this price to compute the (single!) YTM, denoted by y, of the
coupon bond.

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Pricing a Coupon Bond Using YTMn
Problem (Example 6.8 in textbook)

Given the following zero-coupon yields, compare the yield to maturity for a
three-year, zero-coupon bond; a three-year coupon bond with 4% annual
coupons; and a three-year coupon bond with 10% annual coupons. All of these
bonds are default free.

Maturity 1 Year 2 Years 3 Years 4 Years

YTMn 3.50% 4.00% 4.50% 4.75%

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Corporate Bonds
• Since corporations who issue bonds may default, there is a credit risk of
holding corporate bonds.

• Investors are willing to pay less for a risky bond, but the yield of bonds are
calculated using the promised face value.

• Therefore, risky corporate bonds tend to have higher yields to maturity than
risk-free bonds.

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Corporate Bonds: An Example
• Suppose the one-year risk-free interest rate is 4%. Consider a bond with face
value $1000 that matures in one year. If there is no risk of default, then the
price of the bond is
1000
P= = 961.54.
1 + 0.04
• Note that the yield of this bond is equal to 4%.

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Corporate Bonds: An Example
• Suppose it is commonly known that this corporation will default with certainty
and only pay back $900, the price is
900
P= = 865.38.
1 + 0.04
• When computing the yield of this bond, we need to use the promised instead
of the actual cash ows:
1000
YTM = − 1 = 15.56 % .
865.38
• This yield is much higher than the expected return, 4%.

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Corporate Bonds: An Example
• Suppose there is a 50% chance of default, in which case you only receive
$900; otherwise, you receive the full $1000 after one year.

• Because now returns are risky, investors usually demand a risk premium.
Let’s assume here the risk premium is 1.1%, so the cost of capital is 5.1%.

• The fair price of the bond is then

950
P= = 903.09.
1 + 0.051
• The yield of this bond is 1000/903.90 − 1 = 10.63 % , while the expected
return is 5.1%.

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Corporate Bonds: An Example

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Bond Ratings
• “Big three”: Standard and Poor’s (S&P), Moody’s, and Fitch Ratings.
• Investment grade bonds (S&P scale): AAA, AA, A, BBB
• Speculative/junk/high-yield bonds: BB, B, CCC, CC, D

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Bond Ratings and the Financial Crisis
• Readings (optional):
1. Credit rating agencies and the subprime crisis;

2. The credit rating controversy.

• Hundreds of billions of dollars’ worth of these triple-A securities were

downgraded to “junk” status by 2010, and the write-downs and losses came
to over half a trillion dollars.

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Forward Rates

John Hicks (Nobel Laureate in 1972) Robert Shiller (Nobel Laureate in 2013)

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Forward Rates
• Suppose we’re at the co ee hour at LSE in 1925.
• Someone asked: I’m wondering, if I will have $100 to invest in 1926 for one
year, what interest rate I can guarantee today?

• Someone replied: I can help you lock it in!

• What is this rate f2? By law of one price, it should solve
2
(1 + r2) = (1 + r1)(1 + f2).
• Think about it: How to implement this investment?

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