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