BOND ANALYSIS AND

BOND VALUATION

INTRODUCTION:
A bond is a security that is issued in connection with a borrowing
arrangement. The borrower issues (i.e., sells) a bond to the lender for
some amount of cash; the bond is in essence the IOU of the borrower.
The arrangement obligates the issuer to make specified payments to
the bondholder on specified dates. A typical coupon bond obligates the
issuer to make semiannual payments of interest, called coupon
payments, to the bondholder for the life of the bond.
Face Value: face value, par value The payment to the bondholder at the
maturity of the bond.
Coupon Rate: Coupon Rate A bonds annual interest payment per dollar of
par value.

To illustrate, a bond with a par value of $1,000 and a coupon rate of

8% might be sold to a buyer for $1,000. The issuer then pays the
bondholder 8% of $1,000, or $80 per year, for the stated life of the
bond, say, 30 years. The $80 payment typically comes in two
semiannual installments of $40 each. At the end of the 30-year life of
the bond, the issuer also pays the $1,000 par value to the bondholder.

TYPES OF BOND:
Zero-coupon Bond: A bond paying no coupons that sells at a discount and
provides only a payment of par value at maturity

Callable Bonds: A bond that may be repurchased by the issuer at a

specified call price during the call period.
Convertible Bonds: A bond with an option allowing the bondholder to
exchange the bond for a specified number of shares of common stock in the firm.
Put Bond: A bond that the holder may choose either to exchange for par
value at some date or to extend for a given number of years.
Floating-rate Bonds: A bond with coupon rates periodically reset according
to a specified market rate.
Inflation Adjusted Treasury Bond: A bond whose coupon rate changes
with inflation.

Deferred Coupon Bonds: Carry Coupons, but initial coupon payment is

deferred for some period.
Investment Grade Bond: A bond rated BBB and above by Standard &
Poors, or Baa and above by Moodys.
Junk Bond: A bond rated BB or lower by Standard & Poors, or Ba or lower
by Moodys, or an unrated bond.

RISK OF INVESTING IN BOND:

RETURN ON BOND:

BOND PRICING:
The nominal risk-free interest rate equals the sum of (1) a real riskfree rate of return and (2) a premium above the real rate to
compensate for expected inflation. In addition, because most bonds
are not riskless, the discount rate will embody an additional premium
that reflects bond-specific characteristics such as default risk,
liquidity risk, maturity risk, tax attributes, call risk, and so on.

Premium bonds: price > par value, YTM < coupon rate
Discount bonds: price < par value, YTM > coupon rate
Par bonds: price = par value, YTM = coupon rate

BOND PRICING:

Price Formula:

Yield to Maturity:

Current Yield:

BOND RETURN:


A bond has a coupon rate of 10%. Interest rates are expected to
decrease due to a newly instituted economic package. What will happen
to the price of this bond? Why?
How much should you pay for a $1,000 bond with 10% coupon, annual
payments, and five years to maturity if the interest rate is 12%?
A) $ 927.90 B) $ 981.40 C) $1,000.00 D) $1,075.82
)
What is the coupon rate for a bond with three years until maturity, a
price of $1,053.46, and a yield to maturity of 6%?
A) 6% B) 8% C) 10% D) 11%
)
What is the yield to maturity (APR) of a bond with the following
characteristics? Coupon rate is 8% with semi-annual payments, current
price is $960, three years until maturity.
A) 4.78% B) 5.48% C) 9.87% D) 12.17%
)
What is the rate of return for an investor who pays $1,054.47 for a
three-year bond with a 7% coupon and sells the bond one year later for
$1,037.19?
A) 5.00% B) 5.33% C) 6.46% D) 7.00%
)
A two-year bond with par value $1,000 making annual coupon
payments of $100 is priced at $1,000. What is the yield to maturity of the
bond? What will be the realized compound yield to maturity if the one-

Effective Duration
An interpretation of duration is the approximate percentage change in
price for a 1% change in yield. This interpretation, price sensitivity in
response in response to a change in yield.