US listed Chinese (Mainland

China) companies
• Qihoo 360 Technology IPO today.
• There are about 19 Chinese companies listed
in the New York Stock Exchange, including
major Banking, Telecommunication, Energy
and Transportation companies
• Another 16 Chinese companies, mainly .com
companies, are listed on NASDAQ.
• 6 more on London Stock Exchange, 20 on
Singapore.

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 • Aluminum Corporation of China Ltd
China Eastern Airlines Corporation Limited
China Life Insurance Company Limited
China Mobile (Hong Kong) Limited
China Netcom Group Corporation (Hong Kong) Limited
China Petroleum and Chemical Corporation
China Southern Airlines Company Limited
China Telecom Corporation Limited
China Unicom
Guangshen Railway Company Limited
Huaneng Power International Incorporated
Jilin Chemical Industrial Company Limited
Petro China Company Limited
Semiconductor Manufacturing International Corporation
Sinopec Shanghai Petrochemical Company Limited
Suntech Power Holdings Company Limited
Yanzhou Coal Mining Company Limited
4-2
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 The attractiveness of U.S stock
market
• Better international recognition
• Reduce the risk of being taken over by
shareholders
• Raise capital in U.S dollars.
• Diversify.

4-3
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Chapter 4

Understanding
Interest Rates

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 Present Value

• A dollar paid to you one year from now is

less valuable than a dollar paid to you today
• Why?
– A dollar deposited today can earn interest and
become $1 x (1+i) one year from today.

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 Discounting the Future

Let i = .10
In one year $100 X (1+ 0.10) = $110
In two years $110 X (1 + 0.10) = $121
2
or 100 X (1 + 0.10)
In three years $121 X (1 + 0.10) = $133
or 100 X (1 + 0.10)3
In n years
$100 X (1 + i ) n
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 Simple Present Value

PV = today's (present) value

CF = future cash flow (payment)
i = the interest rate
CF
PV = n
(1 + i )

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 Time Line

Cannot directly compare payments scheduled in different points in the

time line

$100 $100 $100 $100

Year 0 1 2 n

PV 100 100/(1+i) 100/(1+i)2 100/(1+i)n

4-8
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 Four Types of Credit Market
Instruments
• Simple Loan
• Fixed Payment Loan
• Coupon Bond
• Discount Bond

4-9
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 Yield to Maturity

• The interest rate that equates the

present value of cash flow payments
received from a debt instrument with
its value today

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 Simple Loan

PV = amount borrowed = $100

CF = cash flow in one year = $110
n = number of years = 1
$110
$100 =
(1 + i )1
(1 + i ) $100 = $110
$110
(1 + i ) =
$100
i = 0.10 = 10%
For simple loans, the simple interest rate equals the
yield to maturity

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 Fixed Payment Loan

The same cash flow payment every period throughout

the life of the loan
LV = loan value
FP = fixed yearly payment
n = number of years until maturity
FP FP FP FP
LV =  2
 3
 ...+
1 + i (1 + i) (1 + i) (1 + i) n

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 Coupon Bond

Using the same strategy used for the fixed-payment loan:

P = price of coupon bond
C = yearly coupon payment
F = face value of the bond
n = years to maturity date
C C C C F
P=  2
 3
. . . + 
1+i (1+i ) (1+i ) (1+i ) (1+i ) n
n

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 Table 1 Yields to Maturity on a 10%-
Coupon-Rate Bond Maturing in Ten Years
(Face Value = $1,000)

• When the coupon bond is priced at its face value, the

yield to maturity equals the coupon rate
• The price of a coupon bond and the yield to maturity are
negatively related
• The yield to maturity is greater than the coupon rate
when the bond price is below its face value

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 Consol or Perpetuity

• A bond with no maturity date that does not repay

principal but pays fixed coupon payments forever

P C / ic
Pc price of the consol
C yearly interest payment
ic yield to maturity of the consol

can rewrite above equation as this : ic C / Pc

For coupon bonds, this equation gives the current yield, an
easy to calculate approximation to the yield to maturity

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 Discount Bond

For any one year discount bond

F-P
i=
P
F = Face value of the discount bond
P = current price of the discount bond
The yield to maturity equals the increase
in price over the year divided by the initial price.
As with a coupon bond, the yield to maturity is
negatively related to the current bond price.
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 Rate of Return

The payments to the owner plus the change in value

expressed as a fraction of the purchase price
C Pt1 - Pt
RET = +
Pt Pt
RET = return from holding the bond from time t to time t + 1
Pt = price of bond at time t
Pt1 = price of the bond at time t + 1
C = coupon payment
C
= current yield = ic
Pt
Pt1 - Pt
= rate of capital gain = g
Pt

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 Rate of Return and Interest
Rates
• The return equals the yield to maturity only if the
holding period equals the time to maturity
• A rise in interest rates is associated with a fall in
bond prices, resulting in a capital loss if time to
maturity is longer than the holding period
• The more distant a bond’s maturity, the greater the
size of the percentage price change associated with
an interest-rate change

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 Rate of Return and Interest
Rates (cont’d)
• The more distant a bond’s maturity, the lower the
rate of return the occurs as a result of an increase
in the interest rate
• Even if a bond has a substantial initial interest rate,
its return can be negative if interest rates rise

4-19
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 Table 2 One-Year Returns on Different-Maturity
10%-Coupon-Rate Bonds When Interest Rates
Rise from 10% to 20%

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 Interest-Rate Risk

• Prices and returns for long-term bonds are

more volatile than those for shorter-term
bonds
• There is no interest-rate risk for any bond
whose time to maturity matches the holding
period

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 Real and Nominal Interest
Rates
• Nominal interest rate makes no allowance
for inflation
• Real interest rate is adjusted for changes in
price level so it more accurately reflects the
cost of borrowing
• Ex ante real interest rate is adjusted for
expected changes in the price level
• Ex post real interest rate is adjusted for
actual changes in the price level
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 Fisher Equation

i ir   e
i = nominal interest rate
ir = real interest rate
 e = expected inflation rate
When the real interest rate is low,
there are greater incentives to borrow and fewer incentives to lend.
The real interest rate is a better indicator of the incentives to
borrow and lend.

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 FIGURE 1 Real and Nominal Interest Rates
(Three-Month Treasury Bill), 1953–2008

Sources: Nominal rates from [Link]/releases/H15. The real rate is constructed using the procedure outlined in
Frederic S. Mishkin, “The Real Interest Rate: An Empirical Investigation,” Carnegie-Rochester Conference Series on Public Policy 15
(1981): 151–200. This procedure involves estimating expected inflation as a function of past interest rates, inflation, and time
trends and then subtracting the expected inflation measure from the nominal interest rate.

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 Treasury Inflation-Protected
Securities (TIPS)
• The principal of a TIPS increases with
inflation and decreases with deflation, as
measured by the Consumer Price Index.
When a TIPS matures, you are paid the
adjusted principal or original principal,
whichever is greater.

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