Académique Documents
Professionnel Documents
Culture Documents
Chapter 4
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or in part.
What Companies Do
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or in part.
Valuation Basics
Expected Return
on Assets
Valuation
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in whole or in part.
The Fundamental Valuation Model
CF 1 CF 2 CF n
P0 = 1
+ 2
+ . . .+
(1 + r ) (1 + r ) (1 + r )n
P0 = Price of asset at time 0 (today)
CFt = Cash flow expected at time t
r = Discount rate (reflecting asset’s risk)
n = Number of discounting periods (usually years)
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whole or in part.
Bond Vocabulary
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whole or in part.
Bond Valuation: The Basic Equation
C C C M
P0 = 1
+ 2
+ . . .+ n
+ n
(1 + r ) (1 + r ) (1 + r ) (1 + r )
C 1 M
P0 = X [1 n
]+
r (1 + r ) (1 + r )n
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whole or in part.
Bond Features
Time 0 1 2 3 4 5
Coupons $80 $80 $80 $80 $80
Face Value $ 1000
$______
• By financial calculator
PMT 80 ($924.18) PV
n 5
r 10%
FV 1000
• By TVM tables
PV of coupons: 80 x PVIFA (10%, 5 yrs)=
80x3.7908=303.264
PV of 1000 = 1000 x PVIF (10%, 5
yrs)=1000*0.6209=620.90
PV =$924.164
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whole or in part.
Fig 4.1 Time Line for Bond Valuation
(Assuming Annual Interest Payments)
Worldwide
United
9.125% Coupon,
$1,000 Par
Value
Bond, Maturing
at
End of 2022;
Required Return
Assumed To Be
8%
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whole or in part.
Yield to Maturity (YTM)
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whole or in part.
On Discount Rates
• Generally,
• the greater the uncertainty about an asset’s
future benefits,
• the higher the discount rate investors will apply
• when discounting those benefits to the
present.
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whole or in part.
Bond premiums and discounts
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whole or in part.
Bond premiums and discounts
• Suppose you own the 10% bond. A year later, interest
rates increase to 12%.
• A new investor would invest either in your bond (10%)
or a new bond with a coupon of 12%. ???
• Your bond has become less valuable, compared to
the current market bonds with the same risk.
• If you wish to sell the bond, you can sell it at a
discount (less than FV).
• Similarly, if r decline to 8%, your bond is now
more valuable. Investors would want a security
paying 10% interest, when the going rate is only 8%.
Your bond will sell at a premium, > FV.
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whole or in part.
Semiannual Compounding
C C C C
F
Price 2 2 2 .... 2
r 1 r 2 r 3 r 2n
(1 ) (1 ) (1 ) (1 )
2 2 2 2
An example....
Value a T-Bond $40 $40 $40 $40
Par value = $1,000 1,000
P0 2 2 2 2
Maturity = 2 years 1 2 3
0.044 0.044 0.044 0.044
4
Coupon rate = 4% 1 1 1 1
2 2 2 2
r = 4.4% per year
= $992.43
$20 $20 $20 $1,020
(1.022) (1.022) 2 (1.022)3 (1.022) 4
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in whole or in part.
How to calculate bonds (TVM&Excel)
– 2. The current yield is the annual coupon divided by the current market price of
the bond:
Current yield = $___ /_____ = 7.5%
Under what conditions will the coupon rate and current yield be the same?
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whole or in part.
Bond discount & premium
3. The yield to maturity (or “YTM”) is the rate that makes the
price of the bond just equal to the present value of its future cash
flows. It is the unknown r in:
$932.90 = $_______ x [1 - 1/(1 + r)10]/r + $_______ /(1 +
r)10
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whole or in part.
Solve the problem
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whole or in part.
Solve the bond
– 1. Calculate the present value of the face value
= $1,000 * [1/1.0820 ] = $1,000 * .21455 = $214.55
– 2. Calculate the present value of the coupon
payments
= $100 * [1 - (1/1.0820)]/.08 = $100 * 9.8181 = $981.81
• Why do the bonds in this and the preceding example have prices
that are different from par?
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whole or in part.
Bond Price Sensitivity to YTM
Bond price
$1,800
Coupon = $100
20 years to maturity
$1,600
$1,000 face value
$1,000
$ 800
2,000
$1,768.62
30-year bond Time to Maturity
1,500
Interest rate 1 year 30 years
5% $1,047.62 $1,768.62
$1,047.62 1-year bond 10 1,000.00 1,000.00
1,000
$916.67
15 956.52 671.70
20 916.67 502.11
500 $502.11
Value of a Bond with a 10% Coupon Rate for Different Interest Rates and Maturities
Bond prices theorem
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whole or in part.
Economic Forces Affecting Bond Prices
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whole or in part.
Fig 4.2 The Relationship Between
Bond Prices and Required Returns
6% coupon rate
for both
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whole or in part.
Interest Rate Risk
• The risk that changes in market interest
Interest Rate rates will cause fluctuations in a bond’s
Risk price. Also, the risk of suffering losses as
a result of unanticipated changes in
market interest rates.
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whole or in part.
Fig 4.3 Treasury Bond Yields and Inflation
Rates 1955- 2010
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whole or in part.
What Companies Do Globally
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whole or in part.
Primary versus Secondary Markets
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whole or in part.
Types of Bonds: By Issuer
• Usually with par $1000 and semi-annual
Corporate coupon
Bonds • Bonds if maturity > 10 years; notes if
maturity < 10 years
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whole or in part.
Table 4.1 Zero-Coupon Bond Prices and
Taxable Income
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whole or in part.
Types of Bonds: By Features
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whole or in part.
Bond Markets
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whole or in part.
U.S. Treasury Bond Quotations
MATURITY ASK
RATE BID ASKED CHG
MO/YR YLD
Government Bonds & Notes
5.500 May 09n 107:13 107:14 3 3.83
SBC
Comm Aug
5.875 107.161 4.836 80 10 73,867
15,2012
(SBC)
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whole or in part.
Table 4.3 The Relationship Between Bond Ratings
and Spreads at Different Maturities at a Point in
Time, Expressed in Basis Points
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whole or in part.
Term Structure of Interest Rates
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whole or in part.
Fig 4.7 The Expectations Theory
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whole or in part.
Advanced Bond Valuation
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whole or in part.
Valuing Bonds
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whole or in part.
Yield Curve/Normal
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whole or in part.
Flat Yield Curve
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whole or in part.
Inverted Yield Curve
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whole or in part.