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Principles of Finance: Unit 5, Semi-Annual v Daily Compounding: Bonds 2 Views


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Description:

What's the difference between semi-annual and daily compounding when it comes to bonds? Get your calendars and calculators out for this one.

Language:
English Language

Transcript

00:00

Principles of finance ah la shmoop semi annual versus daily

00:05

compounding in bonds effective rate All right people This natty

00:11

concept takes into effect the compound ing period That is

00:15

if two bonds are identical in every way except that

00:19

one comp pounds daily and the other compounds semi annually

00:25

while the daily compound er will effectively yield you more

00:29

greenbacks All right if we have an investment of one

00:31

hundred grand in a bond yielding six percent it'll pay

00:33

us three grand in six months And if we just

00:36

kept that cash in the same bond vehicle we now

00:38

have one hundred three thousand on which to then receive

00:42

annualized interest right Like we get that three grand after

00:44

six months we just reinvested in the same bond and

00:47

our com pounding on one hundred three grand right So

00:49

said another way So for the next semi annual period

00:51

we get a three percent return on one hundred three

00:54

grand instead of three percent on just the hundred grand

00:57

that we started with case that's semi annual compounding But

01:00

with daily compounding we get mohr Our little formula here

01:04

should explain how on our first six months or one

01:06

hundred eighty two days of the year we get three

01:09

percent of one plus the quantity one over one eighty

01:13

two it's the same is six percent of the quantity

01:15

won over three sixty four right But after one day

01:18

of one hundred thousand dollars bond we'd have like one

01:21

hundred thousand dollars plus roughly three thousand dollars divided by

01:24

one eighty two which is about sixteen bucks and change

01:27

So then on day two we're compounding on a higher

01:30

base principle of one hundred thousand sixteen dollars Well doesn't

01:33

seem like much but you that every day for a

01:35

whole lot of days it really adds up So what

01:37

if you have a bond yielding twelve percent and it

01:40

actually pays awfully well you owned it five years and

01:43

you think you made a killing homerun right Not necessarily

01:46

What if these work brazilian bonds issued so that they

01:50

were payable in the brazilian currency The ray al Well

01:54

during the five years you owned that twelve percent yielding

01:56

bond brazil saw inflation of twenty percent a year So

02:01

you lost eight percent When you collect your principal at

02:05

the end of these five years you'll go shopping for

02:07

a car and woops It turns out that you actually

02:11

lost eight percent a year at least eight percent a

02:14

year in buying power Your nominal twelve percent yield Actually

02:18

violent stunk You're real Return was a loss of eight 00:02:21.13 --> [endTime] percent a year Nice job there pal

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