Interest Rates and Bond Valuation

INTEREST RATES & BOND VALUATION

Week 2

1F0120 Corporate Finance I Academic Department of Finance Universidad del Pacífico

M. Gonzalo Chávez, CFA

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Outline

I.        The Internal Rate of Return (IRR)

II.        Interest Rates Quotes and Loans

III.        Determinants of Interest Rates

IV.        Bond Prices and Yields

V.        Corporate Bonds

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Internal Rate of Return (IRR)

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Example

• Suppose that you face an investment opportunity that requires a $1000 investment today and will have a $2000 payoff in six years,

• r = IRR = 12.25%

• Therefore, making this investment is equivalent to earning 12.25% per year on your money for six years

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Solving IRR of a Cash Flow Stream[pic 1][pic 2]

• Consider a stream of cash flow,

• The IRR is calculated by solving the r in the NPV = 0 equation below,

• When N > 2, the r may not be solved manually, we need to use a financial calculator or computer softwares (e.g. Excel).

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Outline

I.        The Internal Rate of Return (IRR)

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