Lecture204 - Valuation of Debt Contracts and Their Price...

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Valuation of Debt Contracts and Their Price Volatility Characteristics I Features of debt contracts. A) debt contracts are any contract which specifies a stream of fixed payments at pre- specified times. In this class, we will focus on bonds, the most common form of debt contracts. B) Definitions: Face Value: The amount paid at maturity of the bond. Also known as Par Value or Maturity Value. Coupon Payment: Periodic interest payments made to bond holders during the life of the contract. Let M = Face Value a t = coupon payment at time t n P j = the price j periods from the present of a bond maturing n periods latter. Example: 10 P 5 = Price of a 10-year bond 5 years from now. 10 P 0 = Current price of a 10-year bond. II. Basic Valuation Principles A) Suppose you can borrow or lend at a risk-free interest rate r. What price would you be willing to pay for a debt instrument with a guaranteed cash flow a 1, a 2, a 3, …, a T ? It turns out the only arbitrage-free price of this cash flow is
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This note was uploaded on 04/12/2008 for the course ECON 435 taught by Professor Chabot during the Winter '08 term at University of Michigan.

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Lecture204 - Valuation of Debt Contracts and Their Price...

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