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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter Outline
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Bond Definitions
• Bond: debt securities, interest-only loan
• Par value (face value): loan principal, eg: $1000
• Coupon rate: periodic interest rate
• Coupon payment (c): periodic interest payments
= coupon rate * par
• Time to maturity (t): no. of coupon payment till
maturity date
• Yield to maturity (r) : market required rate of return
on bond. IOW, the discount rate that equals the PV
of cash flows to bond price.
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•Coupon=10% * $1000=$100
•year to maturity= 5
•Yield to maturity=10%
•Cash Flows: year 1 - 4 = $100
year 5 = 100 + 1000 = $1100
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Bond Valuation
Asset value = Present value of all future cash flows
Bond value = PV of all payments discounted at YTM
= PV of coupon + PV of par
= PV of annuity + PV of par
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1 - (1 + r) t F
Bond Value = C +
r (1 + r) t
Where c = coupon payment
r = YTM
t = numbers of period
F = face value (eg:1000)
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Bond valuation-Example
Consider a 5-year corporate bond with a 10%
coupon rate paid annually. The principal amount is
$1000 and the market interest rate is 10%
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Semiannual coupons
• Suppose you are looking at a bond that has a
10% coupon paid semiannually and a face value
of $1000. There are 5 years to maturity and the
yield to maturity is 12%. What is the price of this
bond?
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Computing YTM
• Yield-to-maturity is the rate implied by the
current bond price, i.e., the rate that equals
the PV of bond’s cash flows with bond
price.
• Finding the YTM requires trial and error if
you do not have a financial calculator.
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Bond Yield
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Bond Classifications
• Registered vs. Bearer Forms
• Security: backed by asset
– Collateral – secured by financial securities
– Mortgage – secured by real property, normally
land or buildings
– Debentures – unsecured
– Notes – unsecured debt with original maturity
less than 10 years
• Seniority
– preference in position over other lenders
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Types of bonds-
Government Bonds
• Treasury Securities
– Federal government debt
– T-bills – pure discount bonds with original maturity of
one year or less
– T-notes – coupon debt with original maturity between
one and ten years
– T-bonds- coupon debt with original maturity greater
than ten years
• Municipal Securities
– Debt of state and local governments
– Interest received is tax-exempt at the federal level
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Example
• If we require a 10% real return and we
expect inflation to be 3%, what is the
nominal rate?
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Tutorial
• Problem 6, 10, 17 and 18 from page 196
• Problem 18:
“…sell for 93% of par…” change to
“…sell for 91.167% of par…”
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