BCOR 2200 Chapter 6

# BCOR 2200 Chapter 6 - Chapter 6 Interest Rates and Bond...

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1 Chapter 6 Interest Rates and Bond Valuation

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2 Chapter 6 Outline: 1.Bonds and Bond Valuation 2.More on Bond Features 3.Bond Ratings 4.Some Different Types of Bonds 5.Bond Markets 6.Inflation and Interest Rates 7.Determinants of Bond Yields
3 Key Concepts and Skills: Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean Understand the impact of inflation on interest rates Understand the term structure of interest rates and the determinants of bond yields

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4 6.1 Bonds and Bond Valuation Firs some terminology: A 30 year \$1,000 bond pays \$100 per year (annual payments) and repays the \$1,000 in twenty years. The market requires a 10% return on loans to this company. COUPON = \$100 COUPON RATE = Coupon/Face = \$100/\$1,000 = 10% COUPON PERIOD = Annual FACE VALUE or PAR VALUE = \$1,000 TIME (or TERM) TO MATURITY = 30 years YIELD TO MATURITY (YTM) = required rate = 10%
5 A Bond is Defined (or Identified) by: 1. Issuer A Corporation (corps): GE, GM… A Municipality (munis): Boulder, New York State, E470 Public Highway Authority… The Federal Government (govies): Issued to finance the deficit and debt 2. Maturity Usually a date (but in this class we’ll use a time to maturity) A ten year bond is a 2017 but we’ll call it a ten year. 3. Structure Coupon, Zero, Amortizing 4. Coupon Rate (if applicable) 7% Semi-Annual, 10% Annual… 5. Bond Features Callable, Convertible. .. (we’ll talk about this later) 6. Rating Rating agencies (S&P, Moodys, Fitch…) issue public rating. BBB or higher are investment grade. BB or lower are non-investment grade (junk) Example: GE 5.125 of 2028 (“five and an eights of 28”) GE corp bond. Matures in 2028. Pays a 5.125% S-A coupon. AAA rated

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6 Calculate the price of the bond: 30 year \$1,000 Face or Par Value, 10% annual coupon and 10% required rate (so YTM = 10%) Two Components: 1. Thirty \$100 payments discounted at 10%: PV = C/(1 + r) 1 + C/(1 + r) 2 + C/(1 + r) 3 + … + C/(1 + r) 30 PV = 100/(1.1) 1 + 100/(1.1) 2 + 100/(1.1) 3 + … + 100/(1.1) 30 PV = \$942.69 1. One \$1,000 payment in thirty years PV = FV/(1 + r) 30 PV = 1,000/(1.1) 30 PV = \$57.31 Total Price: = \$942.69 + \$57.31 = \$1,000
7 Calculate the price of the bond using the TVM function: 30 year \$1,000 Face or Par Value, 10% annual coupon and 10% required rate (so YTM = 10%) Two Components: 1. Thirty \$100 payments discounted at 10%: N = 30 I/YR = 10 PMT = \$100 PV = -942.69 1. One \$1,000 payment in thirty years N = 30 I/YR = 10 FV = \$1,000 PV = -57.31 Total Price: = \$942.69 + \$57.31 = \$1,000 OR use the TVM function to do both parts at once: N = 30 I/YR = 10 PMT = \$100 FV = \$1,000 PV = -1000

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Clicker Question: 8

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10 Important thing about a bond’s price: If YTM = Coupon Rate Price = Par If YTM > Coupon Rate Price < Par Priced at a “discount” If YTM < Coupon Rate
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BCOR 2200 Chapter 6 - Chapter 6 Interest Rates and Bond...

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