This chapter outlines basic concepts of compounding and discounting. We show how to calculate the price of a debt security, given discount rates and contractual terms, including coupons and maturity. We provide several examples using Microsoft Excel and illustrate the pricing of Treasury bills, Treasury notes, and bonds. Concepts of accrued interest and yield to maturity are developed and illustrated. The convex relationship between price and yield of a debt security is shown in the context of real-life examples.
2.1 Concepts of Compounding and Discounting
The basics of time value of money and discounting are quite important in understanding how fixed income securities are valued. We review the time ...