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D 360
EIR
100 D CP DP
2% 360
(100 D) (30 10)
2 360
98% 20
(2.04%)(18)
36.72%
Effective Annual Interest Terms
18
i
EAR 1 1
m
EAR (1 .0204) 1
18
EAR 1.439 1
EAR 43.9%
Line of Credit- maximum amount of loan that a borrower can
borrow from the bank. It requires
Compensating balance- amount of deposit, usually a
percentage of the loan obtained
- Should stay in the borrowers checking account
- Cannot be reduced until loan is fully paid
= P100,000 x 8%
P100,000-(20% x P100,000)
= P8,000
P100,000 – P20,000
= P8000
P80,000
= 10%
* Take note that the effective cost of the bank loan is
higher than the nominal interest rate of 8%
The EIR is equal to the nominal rate of 8% because
it is simple interest loan transaction. If the loan is
deducted in advance, the proceeds would be:
Proceeds = Loan – Interest
= P100,000 – P8,000
= P92,000
EIR = Interest
Proceeds
= P8,000
P92,000
= 8.696% or 8.7%
Alternatively, EIR on a discount loan can be computed as
follows:
EIR = Nominal Rate(%)
1- Nominal Rate (fraction or decimal)
= 8%
1 - .08
= .08
.92
= 8.696 or 8.7%
Therefore, discounting has a higher EIR, than simple interest in
a loan transaction with interest paid at maturity date.
Yield to Maturity
Is the interest rate which equates the present value of all
cash flows from the debt instrument with the current
value.
Different ways to measure Yield to Maturity depending
on the type of instrument:
*A. For Simple Loan, YM = simple interest rate
YM = P11,000 – P10,000
P 10,000
= 10%
B. For Coupon Bond in which interest is paid annually and
the principal is paid in maturity period,
( FV PP)
EYM 1
n
( FV PP)
2
Where, 1 is the interest based on normal rate.
FV is the face value of the bond
PP is the purchase price of the bond
n is the number of years before maturity
Example:
( P100 4) P104
P990 P990
10.50%
At 10% At 11%
Present Value of Interest
100[1 (1 .10) 5 ] / .10
379
100[1 (1 .11) 5 ] / .11
370
At 10% PV 1,000
At 11% PV 963
Difference 37
20
54%
37
Therefore the exact yield to maturity (YM) would be:
YM = Nominal Rate + .54% = 10.54%
C. Current Yield (CY) is the yearly coupon payment (C)
divided by the price of the security (P)
C
CY
P
Bonds with a purchase price of P980 and a yearly
coupon payment of P100 will have a current yield of 10.20%.
Computed as:
P100
CY
P980
10.20%
Real Risk-Free Rate of Interest (k*)
- the interest rate that would exist on a riskless security if
zero inflation were expected.