Basic Terminology

Some of the matters discussed herein are excerpted from

Time Value of Money:  A dollar today is worth more than a dollar tomorrow.

Revenue Bond Index: Index computed by the Bond Buyer every Thursday and published every Friday. Index is based on the average rates of 25 selected revenue bonds with 30 year maturities.

Standard Measure of Risk Premium:  The different between interest rates on tax-exempt debt and those on short-term Treasury bonds is a standard measure of the risk premium that investors require in order to hold bonds.

Current Yield: Annual interest payment ÷ current market price of the bond.

Day Count Basis: The method of counting the number of days between two dates.  See the Wikipedia entry for additional information.

  • Banker’s Year/US: 30/360 convention (Excel = 0);
  • Actual/360: Counts actual number of days but assumes a year of 360 days (Excel = 2);
  • Actual/365: Counts actual number of days but assumes a year of 365 days (i.e., it ignores leap years) (Excel = 3);
  • Actual/Actual: Counts actual number of days and uses actual number of days in the year (Excel = 1); and
  • European 30/360: (Excel = 4).

Settlement Date:  This is the date the bond formally changes hands, and is usually several days after the trade date.  In the U.S., the settlement date is usually three days after the trade date.  Interest begins to accrue on the settlement date.

Discount Rate: This is the rate that is used to convert between future values and present values. The process of calculating present values is often referred to as “discounting” because present values are generally less than future values.

Internal Rate of Return:  This is the compound average annual rate of return that is expected to be earned on an investment held to maturity in which all cash flows are reinvested at the same rate as the IRR.  Investments that have an IRR of greater than the weighted average cost of capital should be accepted.  The Modified IRR is the same as the IRR, except that it is assumed that the reinvestment occurs at some other rate – usually at the cost of capital rate.

Municipal Market Advisors and Municipal Market Data:  Municipal Market Advisors and Municipal Market Data (a Thompson service) each provide a service that in the afternoon of each trading day makes available generic pricing scales for different bond maturities and different credit ratings.

Net Present Value:  This is the present value of a cash flow less the cost of the investment.  It is a measure of cost versus benefit.  If an investment has a negative net present value, this means the cost of the investment is greater than the present value of the expected cash flow. Think twice before investing in a net present value investment.

Rule of 72:  Rule of thumb for determining how long it takes for an amount to double at a given interest rate.  Of course, it can also be used to determine the interest rate required in order to double the amount during a given time period.  To determine how long it will take to double the amount for a given rate, simply divide 72 by the rate.  E.g., it will take 7.2 years to double the amount if the rate is 10%.  To determine the required rate to double an amount, simply rearrange the formula.  E.g., to double the amount within 5 years, divide 72 by 5, which equals 14.4%.

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