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
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
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
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
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
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
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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