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Amortised Cost Effective Interest rate Effective interest method Effective interest rate ( Examples) Fixed and Floating Interest Rate Interest Cap and Floor LIBOR
Amortised Cost
Amortised cost is the amount at which the financial asset or financial liability is measured: at initial recognition minus any principal repayments; plus or minus the cumulative amortization of the premiums or discounts on the instrument, Plus or minus fees and costs that are an integral part of the effective interest rate; and minus any reduction for impairment or lack of collectability. The amortization calculation should use the effective interest rate (not the nominal rate of interest
Nominal rate- % 1 5 10 15
[1 + (i/n)]n - 1
Where: i = the nominal rate n = the number of payment periods in one year Let's assume you purchase a Company XYZ bond that has a 5% coupon. The nominal rate is 5%. If the interest is paid semiannually, number of payment periods in one year is two. Using the formula above, we can calculate that the effective yield is: [1 + (.05/2)]2 - 1 = .05062 or 5.062%
Amortisation Schedule
Period Payment- A Actual Interest Amount: B (0.06*D) Amortisation Amount: C=B-A Carrying Value :D+C
4
5
5,000
5,000
5,890.00
5,943.40
890.00
943.40
99,056.60
100,000.00
Amortisation Schedule
Period Opening Balance N 800,000 832,552 864,463 908,080 951,785 Payment Interest for the period N 82,552 85,911 89,617 93,705 98,215 Capital Repaid N -32,553 -35,911 -39,617 -43,705 -951,785 Closing Balance N 832,552 868,463 908,080 951,785 -
N
50,000 50,000 50,000 50,000 1,050,000
1 2 3 4 5
N82,552
N85,911
CR
N89,617
N93,705
CR N951,785 N98,215
Interest rate cap is a limit on the maximum interest rate or maximum change in the interest rate allowable.
An interest rate collar combines the effect of both interest rate cap and floor
LIBOR
London Interbank Offered Rate - LIBOR is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market. LIBOR is an important rate that influences many financial instruments. In addition to providing an interbank lending rate and baseline for other lending rates, LIBOR also influences derivatives. Eurodollar futures and interest rate swaps are derivatives that are influenced significantly by LIBOR. LIBOR is the interest rate that banks charge each other for one-month, threemonth, six-month and one-year loans.
Teasers
Give two examples of financial instrument measured at amortised cost Other names for effective interest rate is what? What makes effective interest rate different from nominal interest rate? Interest rate cap and floor are examples of what activities ? Can future losses be included in the calculation of effective interest rate? What is a strike Price? What is the full meaning of LIBOR?