nominal value

Examples of nominal value in the following topics:

• Dollar Returns

  • The dollar return is the difference between the final value and the initial value in nominal terms.
  • The dollar return of a security is the difference between the initial and ending value.
  • The dollar return does not take into account things like the time value of money or how the amount of return earned per year; it is simply the difference in nominal values.
  • Dollar returns are valuable for comparing the nominal differences in investments.
  • The dollar return is the difference in value from year to year, plus the previous dollar return.

• Comparing Interest Rates

  • However, it is not enough to simply compare the nominal values of two interest rates to see which is higher.
  • The reason why the nominal interest rate is only part of the story is due to compounding.
  • Inflation causes a nominal amount of money in the present to have less purchasing power in the future.
  • Thus, Company 2 is the better investment, even though Company 1 pays a higher nominal interest rate.
  • The nominal interest rate is approximately the sum of the real interest rate and inflation.

• Differences Between Real and Nominal Rates

  • Nominal rate refers to the rate before adjustment for inflation; the real rate is the nominal rate minus inflation: r = R - i or, 1+r = (1+r)(1+E(r)).
  • The real rate is the nominal rate minus inflation.
  • A lender would have no net benefit from such a loan because inflation fully diminishes the value of the loan's profit.
  • The relationship between real and nominal rates can be described in the equation:
  • Where r is the real rate, i is the inflation rate, and R is the nominal rate.

• The Relationship Between Present and Future Value

  • Present value (PV) and future value (FV) measure how much the value of money has changed over time.
  • The future value (FV) measures the nominal future sum of money that a given sum of money is "worth" at a specified time in the future assuming a certain interest rate, or more generally, rate of return.
  • The value does not include corrections for inflation or other factors that affect the true value of money in the future.
  • On the other hand, the present value (PV) is the value on a given date of a payment or series of payments made at other times.
  • If there are multiple payments, the PV is the sum of the present values of each payment and the FV is the sum of the future values of each payment.

• Calculating Values for Different Durations of Compounding Periods

  • Luckily, it's possible to incorporate compounding periods into the standard time-value of money formula.
  • In this equation, A(t) corresponds to FV, A0 corresponds to Present Value, r is the nominal interest rate, n is the number of compounding periods per year, and t is the number of years.
  • This formula allows you to figure out how many periods are needed to achieve a certain future value, given a present value and an interest rate.
  • Finding the FV (A(t)) given the PV (Ao), nominal interest rate (r), number of compounding periods per year (n), and number of years (t).
  • Calculate the present and future value of something that has different compounding periods

• Calculating the Yield of a Single-Period Investment

  • The most basic type of yield calculation is the change-in-value calculation.
  • This is simply the change in value (FV minus PV) divided by the PV times 100%.
  • Nominal APR is simply the interest rate multiplied by the number of payment periods per year.
  • The percent change in value is the change in value from PV to FV (V2 to V1) divided by PV (V1) times 100%.
  • The Annual Percentage Yield is a way or normalizing the nominal interest rate.

• Time to Maturity

  • "Time to maturity" refers to the length of time that can elapse before the par value (face value) for a bond must be returned to a bondholder.
  • The issuer of a bond has to repay the nominal amount for that bond on the maturity date.
  • In general, coupon and par value being equal, a bond with a short time to maturity will trade at a higher value than one with a longer time to maturity.
  • Where the market price of a bond is less than its face value (par value), the bond is selling at a discount.
  • Discuss the importance of a bond's maturity when determining its value

• The Fisher Effect

  • We only discussed nominal interest rates.
  • We did not adjust the nominal interest rates for inflation.
  • The Fisher Effect relates nominal and real interest rates and we define the notation as:
  • Investors know the inflation would erode the value from their investment while businesses could repay the bonds with inflated dollars.
  • Financial analysts always write interest rates for financial instruments in nominal terms.

• Inflation Premium

  • In economics and finance, an individual who lends money for repayment at a later point in time expects to be compensated for the time value of money, or not having the use of that money while it is lent.
  • The inflation premium will compensate for the third risk, so investors seek this premium to compensate for the erosion in the value of their capital, due to inflation.
  • The Fisher equation in financial mathematics and economics estimates the relationship between nominal and real interest rates under inflation.
  • In economics, this equation is used to predict nominal and real interest rate behavior.
  • Letting r denote the real interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher equation is: i = r + π.

• Par Value

  • Par value/face value (also known as the principal) is the amount of money a holder will get back once a bond matures.
  • Par value means stated value or face value in finance and accounting.
  • From this comes the expressions at par (at the par value), over par (over par value) and under par (under par value).
  • A newly issued bond usually sells at the par value.
  • Another name for this effect is "reduction of maturity. " It results from the difference between market interest rate and the nominal yield on the bond.