Relationship between bond prices and interest rates

[turtlebei]

thx a lot. this really helps a lot, esp with the sub-titles for non-english speaker like me. keep it up.

[johnpe21]

sorry but what does the interest rate stands for ? it is different from the coupon ? Isn't the coupon rate prescribed from the beginning of the "contract"?



[shazeem14]

thank you so much!

[alyacoke]

Now, I finally understand! Thank you!

[5zainab11]

thanx a lot

[paulceltics]

good music

[CC4ntStopW0NtStop]

Ahhhhh... fuck... Thank You... I have a midterm on this shit next week.... I been looking all over youtube for this shit.... Fuck your awesome!!!!!!!!

[smokenfly514]

So basically, when interest rates are going up, as they are now, bonds are a bad investment, because in general their prices will fall? Am I understanding correctly? So when the economy is suffering, their prices go up, but afterward it's better to turn to equities?

If it's that simple, how can you speculate and play around with bonds rather than just buy and hold?

Thanks a lot!

[ThomasCHolland]

@smokenfly514 Interest rates typically move alongside inflation (as one goes up, the other goes up). The tricky part, for investors, is when the Fed does things to manipulate that process. For example, to help the economy rebound, the Fed can artificially keep interest rates low.

[skyfaze]

TYTYTY:D

[waelben2000]

is it that whenever u say coupon it will always mean 1 year and we have to divide the rate by 2 in order to get the answer? thanks!

[waelben2000]

Khan didn't u say in the previous video that 10% coupon per year is calculated semi annually and that is why we divide $100/2= $50? how come in this video you say that it is 10% semi annually and not write $100 for each 6 months?

[thegoonist]

anyone know who sets the interest rates for the zero coupon?

and its a little confusing in the video when for the first bond the par value ($1000) was placed on the bond cert and for the second bond the $1000 on the bond cert wasn't referring to the par value but the final payment.

[kittereen]

I'm confused about the second part of this video. The way bonds were explained made them sound like the interest was not compounded. For a $1000 bond at 10% for 2 years, you would end up with $1200, a factor of 1.2. If this were compound interest, it would have been 1.21.

If we were calculating what someone would be willing to pay it would be original value / (1 + interest * years). In the first example with 10%, this results in $833.

[02280228]

thanks!! I always wonder what a bond actually is, they always talk about it on tv but never really explain what it means to buy a bond... so very helpful!!

[DavidAKZ]

Good explanation. Here's a question. Are the interest rates set by Central Bank 'x' or is if a function of the bond market ? thanks

[kurktchian]

Interest rate controls future production.... the interest rate should represent the savings in the economy, high savings rate = low interest rate since people will spend in the future (because they are saving now) then businesses expand long run projects etc....

But central bank sets the interest rate (manipulates)

[DavidAKZ]

@kurktchian Thanks for the reply. I'm still a bit confused. If Bond traders buy and sell bonds and the price varies according to the bond market surely the corresponding interest rate changes as a result of the buy and sell activity ? re high savings rate == low interest rate, I can can only agree with if you are a speculator, consumer. If you want to be rewarded for saving and not speculating I imagine you would want to be rewarded with high interest rates esp if you are old and retired.

[ThatIsNotDeadWhich]

The reason you want a low (real) interest rate is that it makes the future expensive.

The interest rate is a significant component of the discount rate, which is the rate at which the future is cheaper than the present.

For instance, in order to build a wind farm, you have to pony up a lot of money in the present, but operation and maintenance are essentially free. In order to build a gas burner, you have to pony up only a little money in the present, but fuel is expensive.

[ThatIsNotDeadWhich]

Since the future is important (it is where you and I are going to spend the rest of our lives), we don't want to make it too cheap.

After all, if you make the future very cheap, people would be more inclined to poison the water, pollute the air and break the banking system for a profit in the present.

And we don't want that, because wealth is worthless if we do not, as a species, live long enough to spend it.

[DavidAKZ]

@Which What you saying re you wind farm example, is that in the present building a farm is capital intensive and low interest rates make building possible by borrowing where it would not otherwise have been. Is that what you are saying? If so, my point is does this argument apply to Credit derivatives market that is 10e5 larger than the total output of goods and services of the world in any one year. ? A market that has no relation to capital intensive goods and service production ?

[ThatIsNotDeadWhich]

@DavidAKZ Yes, you're reading my wind farm example right.

The godawful mess that is the credit derivatives business is a longer story that begins with the de-industrialisation and financial deregulation policies of Ronnie Raygun and his friends.

Low interest rates allowed the latest couple of bubbles to happen, but so did a de-fanged SEC and a Congress that was utterly subservient to Wall Street. In a mess this big, blaming a single cause is almost always misleading.

[ThatIsNotDeadWhich]

Well, no. In a monetary economy, interest rates do not represent (only) the cost of capital - they also represent the cost of liquidity.

Furthermore, in an industrial economy, there is no natural relationship between savings, investment and interest rates. Such a "natural" relationship belongs in the fictional alternative universe where financial markets are efficient, transparent and competitive.

[ThatIsNotDeadWhich]

The central bank can set a minimum short-term interest rate, because it can demand interest on the discount window and grant interest on deposits (alternatively, it can conduct open-market operations and set margin requirements).

It cannot set an upper bound, however, and it has limited control of long-term interest rates. So when you hear that the central bank has "lowered the interest rate," what it means is that it has lowered the *minimum short term* interest rate.

[thegoonist]

@ThatIsNotDeadWhich what do you mean by minimum short term rate? rate of what? bonds? loans? interest rate on deposits?

and how short is short term? =S

[ThatIsNotDeadWhich]

@thegoonist "Short term" is traditionally taken to mean less than a year, but the precise time horizon depends on the general fears of inflation and/or sovereign default. In extremis, "short term" can be as short as the overnight interbank rate.

And the central bank's minimum short term rate applies to everything - bonds, loans, deposits (and, indirectly, securities). But remember that it is a minimum - profits and risk premium are added to it, giving the different interest rates you see.

[thegoonist]

@ThatIsNotDeadWhich oh ok thanks. i dont really understand the "profits and risk premium" and "interbank rate" part but i think i get the gist!

[ThatIsNotDeadWhich]

@thegoonist The overnight interbank rate is the rate that banks charge for revolving credit ("overdraft," if you will) to other banks. The risk premium is how likely the bank thinks it is that you will not be paying back the money on schedule. Profits is what is left over once the risk-free interest rate and the risk premium have been subtracted.

One of the problems in the present financial crisis is that banks operated with negative real profits because they set the risk premium too low.

[thegoonist]

@ThatIsNotDeadWhich lol im getting more confused with all the new terms youre throwing out like "revolving credit" and your definition of profit sounds really convoluted! haha are you a finance major?

[ThatIsNotDeadWhich]

@thegoonist Econ major, actually.

"Revolving credit" is like a credit card debt. All banks in a country have "credit cards" with all other banks (except they normally don't charge each other an arm and a leg - that's reserved for the customers...), and the shortest "short term" interest rate possible is the interest rate on banks' "credit cards" with other banks.

Measuring banking profit is a bit convoluted - banking panics happen because it gets too convoluted for the banks themselves.

[thegoonist]

@ThatIsNotDeadWhich o ic see. but how does the bank's credit card work? they deposit their money in other banks? why would they do that why they could just keep it themselves?

btw if you dont mind me asking, where did you study econs?

[ThatIsNotDeadWhich]

@thegoonist Do study, present tense :-P And in Copenhagen.

Banks deposit money in other banks because it will earn them a little interest, rather than no interest on funds that they have no better use for at the moment.

Khan has an excellent series on finance and banking, that will actually teach you more about how the financial system works than most orthodox econ textbooks...

[thegoonist]

@ThatIsNotDeadWhich ok ill check them out. thanks again for all your help! sad that i wont get to talk to you in person, you sound like a really interesting guy lol!

[jhardknox]

@DavidAKZ The rate is first set by what the market will buy. Then, once the securities are in the market and trading, the issuer needs to raise the interest rate when the holders are willing to sell at a discount, otherwise the buyers would have no incentive to purchase from the issuer and just make a trade with the sellers. If buyers are willing to pay at a premium from the sellers, the issuer lowers the rate because the buyers are willing to take a lower return on investment.

[OnePresidentOfPeace]

this was helpful, thanks.

hahaa i like your calculator, it looks so cool when u use it