Chapter 10 and 11 - Chapter 10 1 BOND PRICES AND YIELDS Bond Valuation and Portfolios bond characteristics(I 2 Bond Security that promises specified

Chapter 10 and 11 - Chapter 10 1 BOND PRICES AND YIELDS...

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BOND PRICES AND YIELDS Chapter 10 1 Bond Valuation and Portfolios
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bond characteristics (I) Bond : Security that promises specified payments over a specified period of time Face (par) value : Payment at maturity of the bond Coupon rate : Annual interest payment per dollar of par value Maturity : Date at which the face value is paid Yield to maturity (YTM) : Annual return required of the bond Zero-coupon bond : Bond that promises a single payment at maturity, i.e. bond with no coupon payments 2 Bond Valuation and Portfolios
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bond characteristics (II) Callable bond : Bond that can be repurchased by the issuer at a specified call price during the call period Convertible bond : Bond with an option to be converted into a specified number of common stock Puttable bond : Bond with an option to be redeemed for par value at some date or extended for a specified number of years by the holder Floating-rate bond : Bond with coupon rate that is regularly adjusted with respect to a specified market interest rate 3 Bond Valuation and Portfolios
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example on TIPS Calculate the cash flows from a 5-year TIPS (Treasury Inflation Protected Security) that was issued on January 1, 2004 with $100 face value and 5% coupon rate with annual coupon payments if the annual inflation rate between 2004 and 2008 turned out to be 3%, 3%, 3%, 4%, and 3%, respectively. 4 Bond Valuation and Portfolios Year Inflation Par Value Coupon Cash Flow 2004 3% $103.00 $5.15 $5.15 2005 3% $106.09 $5.30 $5.30 2006 3% $109.27 $5.46 $5.46 2007 4% $113.64 $5.68 $5.68 2008 3% $117.05 $5.85 $122.90
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bond pricing Required rate of return of bonds compensates for (1) real risk- free rate, (2) expected inflation rate, (3) interest rate risk, and (4) bond-specific characteristics such as default risk, liquidity, tax attributes, call risk. 5 Bond Valuation and Portfolios YTM < c premium bond YTM = c par bond YTM > c discount bond This is the mathematical formula You can also use your financial calculator to solve these problems T T T T t t YTM F YTM YTM C YTM F YTM C PV PV 1 1 1 1 1 1 value Face Coupons value Bond 1
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example on bond pricing A company is planning to issue a 20-year bond with a face value of $1,000 and a coupon rate of 6% with semiannual coupon payments. What will be the price of the bond if the YTM of the bond is expected to be 8%? 6 Bond Valuation and Portfolios FV = 1000; PV = ?; PMT = 30; T = 20X2 = 40; INT = 4% 07 . 802 $ 04 . 0 1 000 , 1 $ 04 . 0 1 1 1 04 . 0 30 $ 40 2 20 % 4 2 08 . 0 30 $ 2 06 . 0 000 , 1 $ 40 40 PV t R C S S
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bond yields (I) Yield to maturity (YTM) : Discount rate that makes the present value of bond’s cash flows equal to its price Example on YTM : The PG bond with February 1, 2034 maturity
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