1) Par
value
(Par):
1000
Coupon
(C):
$100
Discount
rate
(k):
5%
Number
of
periods
(n):
4
2) Par
value
(Par):
1000
Coupon
(C):
$50
Discount
Rate
(k):
5%
Number
of
periods
(n):
5
Which
bond
is
more
valuable
today?
PV
=
(C/(1+k))^1+(C/(1+k))^2+…+((C+Par)/(1+k))^n
What
is
the
intuition
behind
each
term
in
the
equation
above?
If
k
is
the
prevailing
market
interest
rate,
what
is
the
Example
2,
Impact
of
timing:
What
is
the
present
value
of
$100,000
5
years
from
now?
What
is
the
present
value
of
$100,000
10
years
from
now?
What
is
the
present
value
of
$100,000
30
years
from
now?
Assume
a
10%
discount
rate.
Example
3:
Valuation
with
semiannual
payments
PV
(semiannual)
=
((C/2)/(1+k/2))^1+((C/2)/(1+k/2))^2+…+((C/2+Par)/(1+k/2))^2n
Relationship
between
coupon
rate,
required
return,
and
bond
price
Example
4:
Price
of
a
zero
coupon
bond
(no
coupon
payments)
1) Par
value
(Par):
$1000
Coupon
(C):
$0
Discount
Rate
(k):
5%
Number
of
periods
(n):
5
2) Par
value:
(Par):
$1000
Coupon
(C):
$0
Discount
Rate
(k):
5%
Number
of
periods
(n):
10
Example
5:
Impact
on
price
of
changes
in
market
interest
rates
1) Par
value
(Par):
$1000
Coupon:
(C):
$50
Discount
Rate
(k):
5%
Number
of
periods
(n):
5
2) Par
value:
(Par):
$1000
Coupon:
(C):
$50
Discount
Rate
(k):
10%
Number
of
periods
(n):
5
3) Par
value
(Par):
$1000
Coupon
(C):
$50
Discount
rate
(k):
1%
Number
of
periods
(n):
5
Bond
Price
Elasticity
Example
6:
Pe=
(%
change
in
P
/
%
change
in
k)
Compare
the
elasticity
of
this
bond
with
the
one
above:
1) Par
value
(Par):
$1000
Coupon:
(C):
$100
Discount
Rate
(k):
5%
Number
of
periods
(n):
5
2) Par
value:
(Par):
$1000
Coupon:
(C):
$100
Discount
Rate
(k):
10%
Number
of
periods
(n):
5
Duration
Example
7
Duration
is
an
alternate
measure
of
a
bond’s
price
sensitivity.
It
is
the
measurement
of
the
life
of
the
bond
on
a
present
value
basis.
n C *t ∑ (1+t k)t DUR
=
t n=1
Ct ∑ (1+ k)t t +1
What
is
the
duration
of
a
bond
with
these
characteristics?
Par
value:
(Par):
$1000
€ Coupon:
(C):
$100
Discount
Rate
(k):
5%
Number
of
periods
(n):
3
What
is
the
duration
of
a
zero
coupon
bond
with
the
same
characteristics
as
the
bond
above
(except
coupon
=
0)?
The
duration
of
a
zero-‐coupon
bond
is
always
equal
to
the
bonds
term
to
maturity.
Modified
Duration
An
estimate
of
the
impact
of
a
change
in
the
prevailing
bond
yields
on
bond
prices.
DUR*
=
DUR/(1+k),
where
k
is
the
prevailing
market
yield
If
k=10%,
what
is
the
modified
duration
of
a
bond
with
duration
10?
With
duration
15?
%
Δ
P
=
-‐DUR*
x
Δ y,
where
%
Δ
P
is
the
percentage
change
in
the
bond’s
price
and
Δ y
is
the
change
in
yield.
If
a
bond
has
a
DUR*
of
5
and
market
bond
yields
increase
by
2%,
what
would
be
the
€ € € impact
on
price?
€