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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,11/7/2009,#,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,8-,*,Interest Rates and Bond Valuation,Chapter 8,Copyright,2010 by the,McGraw-Hill Companies,Inc.All rights reserved.,McGraw-Hill/Irwin,Key Concepts and Skills,Know the important bond features and bond types,Understand bond values and why they fluctuate,Understand bond ratings and what they mean,Understand the impact of inflation on interest rates,Understand the term structure of interest rates and the determinants of bond yields,Chapter Outline,8.1Bonds and Bond Valuation,8.2Government and Corporate Bonds,8.3Bond Markets,8.4Inflation and Interest Rates,8.5Determinants of Bond Yields,8.1 Bonds and Bond Valuation,A bond is a legally binding agreement between a borrower and a lender that specifies the:,Par(face)value,Coupon rate,Coupon payment,Maturity Date,The yield to maturity is the required market interest rate on the bond.,Bond Valuation,Primary Principle:,Value of financial securities=PV of expected future cash flows,Bond value is,therefore,determined by the present value of the coupon payments and par value.,Interest rates are inversely related to present(i.e.,bond)values.,The Bond-Pricing Equation,Bond Example,Consider a U.S.government bond with as 6 3/8%coupon that expires in December 2013.,The,Par Value,of the bond is$1,000.,Coupon payments,are made semiannually(June 30 and December 31 for this particular bond).,Since the,coupon rate,is 6 3/8%,the payment is$31.875.,On January 1,2009 the size and timing of cash flows are:,Bond Example,On January 1,2009,the required yield is 5%.,The current value is:,Bond Example:Calculator,PMT,I/Y,FV,PV,N,PV,31.875=,2.5,1,000,1,060.17,10,1,000,0.06375,2,Find the present value(as of January 1,2009),of a 6 3/8%coupon bond with semi-annual payments,and a maturity date of December 2013 if the YTM is 5%.,Bond Example,Now assume that the required yield is 11%.,How does this change the bond,s price?,YTM and Bond Value,800,1000,1100,1200,1300,0,0.01,0.02,0.03,0.04,0.05,0.06,0.07,0.08,0.09,0.1,Discount Rate,Bond Value,6 3/8,When the YTM coupon,the bond trades at a discount.,Bond Concepts,Bond prices and market interest rates move in opposite directions.,When coupon rate=YTM,price=par value,When coupon rate YTM,price par value(premium bond),When coupon rate YTM,price par value(discount bond),Interest Rate Risk,Price Risk,Change in price due to changes in interest rates,Long-term bonds have more price risk than short-term bonds,Low coupon rate bonds have more price risk than high coupon rate bonds.,Reinvestment Rate Risk,Uncertainty concerning rates at which cash flows can be reinvested,Short-term bonds have more reinvestment rate risk than long-term bonds.,High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds.,Maturity and Bond Price Volatility,C,Consider two otherwise identical bonds.,The long-maturity bond will have much more volatility with respect to changes in the discount rate.,Discount Rate,Bond Value,Par,Short Maturity Bond,Long Maturity Bond,Coupon Rates and Bond Prices,Consider two otherwise identical bonds.,The low-coupon bond will have much more volatility with respect to changes in the discount rate.,Discount Rate,Bond Value,High Coupon Bond,Low Coupon Bond,Par,C,Computing Yield to Maturity,Yield to maturity is the rate implied by the current bond price.,Finding the YTM requires trial and error if you do not have a financial calculator and is similar to the process for finding r with an annuity.,If you have a financial calculator,enter N,PV,PMT,and FV,remembering the sign convention(PMT and FV need to have the same sign,PV the opposite sign).,YTM with Annual Coupons,Consider a bond with a 10%annual coupon rate,15 years to maturity,and a par value of$1,000.The current price is$928.09.,Will the yield be more or less than 10%?,N=15;PV=-928.09;FV=1,000;PMT=100,CPT I/Y=11%,YTM with Semiannual Coupons,Suppose a bond with a 10%coupon rate and semiannual coupons has a face value of$1,000,20 years to maturity,and is selling for$1,197.93.,Is the YTM more or less than 10%?,What is the semi-annual coupon payment?,How many periods are there?,N=40;PV=-1,197.93;PMT=50;FV=1,000;CPT I/Y=4%(Is this the YTM?),YTM=4%*2=8%,Current Yield vs.Yield to Maturity,Current Yield=annual coupon/price,Yield to maturity=current yield+capital gains yield,Example:10%coupon bond,with semi-annual coupons,face value of 1,000,20 years to maturity,$1,197.93 price,Current yield=100/1197.93=.0835=8.35%,Price in one year,assuming no change in YTM=1,193.68,Capital gain yield=(1193.68 1197.93)/1197.93=,-.0035=-.35%,YTM=8.35-.35=8%,which is the same YTM computed earlier,Bond Pricing Theorems,Bonds of similar risk(and matur
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