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Unformatted text preview: Bonds and Their Valuation CHAPTER 7 Bon ds and The ir Val uat ion Val uat ion Yiel ds, Disc oun ts, and Prem iums Ter m Struc ture Risk and Du ration FIN 340 3  Bus iness Finan ce Bas ics Bond Issuers Treasury bonds Corporate bonds Municipal bonds Foreign bonds Bonds Types First mortgage bonds Second mortgage bonds Debentures Subordinated debentures Zero coupon bonds Income bonds Convertible bonds Bonds: Terminology Bond Par value Maturity Coupon interest rate Coupon payment Bond rating Call provision Sinking fund Bond Symbols I = Interest M = Maturity value N = Number of periods V B = Value of the bond r D = Required / discount / YTM rate Bond Cash Flows 0 1 2 N V CF 1 CF 2 CF N r = i Per PV = + + … + CF 1 CF 2 CF N (1+r) 1 (1+r) 2 (1+r) N Bond Cash Flows 0 1 2 N V Coupon Coupon Coupon Maturity PV = + +…+ + Coupon Coupon Coupon Maturity (1+r) 1 (1+r) 2 (1+r) N (1+r) N r = i Per = r D /2 Bond Valuation There is an inverse relationship between the required rate and the price of the bond. r D > Coupon rate V < $1,000 r D = Coupon rate V = Bond Valuation 5Year bond: N = 10 Coupon rate = 10%: I = $50 r D = 12% V < $1,000 V = [$50][PVIFA 6%,10 ] + [$1,000][PVIF 6%,10 ] Effective Annual Rate Can use either i Per or EAR to find the value of the maturity value: EAR = (1.06) 2 1.0 = 12.36% [$1,000][PVIF 6%,10 ] = $558.40 [$1,000][PVIF 12.36%,5 ] = $558.40 Inputs 10 6 50 1,000 Outputs 926.40 N I/YR PV PMT FV Calculation Using the 10B Clear All But there is no reason not to price both the coupon and maturity payments at the same time using i Per . Bond Valuation 5Year bond: N = 10 Coupon rate = 10%: I = $50 r D = 10% V = $1,000 V = [$50][PVIFA 5%,10 ] + [$1,000][PVIF 5%,10 ] Bond Valuation 5Year bond: N = 10 Coupon rate = 10%: I = $50 r D = 8% V > $1,000 V = [$50][PVIFA 4%,10 ] + [$1,000][PVIF 4%,10 ] Bon ds and The ir Val uat ion Val uat ion Yiel ds, Disc oun ts, and Prem iums Ter m Struc ture Risk and Du ration FIN 340 3  Bus iness Finan ce Bas ics Yield to Maturity A bond’s yield to maturity (YTM), also called the “promised yield”, is the rate of return which will be earned if the bond is held to maturity. Yield to Maturity Since bonds have a known cash flow (they are called fixedincome securities), we assume that they are always in equilibrium and that their YTM is also equal to the investors’ required rate of return....
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 Spring '06
 Tapley
 Finance, Interest Rates, Valuation

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