valuation of bonds.pptx - Valuation of Bonds What is a Bond...

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Valuation of Bonds
What is a Bond?
Valuation of Bond An investor buys a bond for its future cash flows. To evaluate a bond, therefore, we have to find the present value of the cash flows For a bond, we need to find the present value of all the interest payments and the present value of the final payment, namely, the face amount of the bond.
Important Concepts Face/Par Value: The first characteristic of a bond is its face, or par value. This represents the amount of principal that a bondholder will receive at maturity, and is also the value that that a bond is issued for at the time that a company or government first sells them. The majority of corporate bonds today carry a face value of $1,000, but may vary by issuer The Market Value: Although a bond may have a face value of $1000, it may not sell at $1000 in the bond market. If the issuing company is not doing well financially, its bonds may sell for less than $1000, perhaps at $950; the bond is selling at a discount. If the market value of the bond is more than $1,000, and then it is selling at a premium . A bond, which is priced at its face value, is selling at par. Coupon : A bond’s coupon rate is the amount of interest income it earns each year based on its face value.
Characteristics of Bond Let’s look at an example of Coupon vs Yield: Suppose a bond has a $1,000 face value and issues semi-annual interest payments of $20, totalling $40 a year. Its coupon rate is 4%. That coupon is fixed. No matter what price the bond trades for, it will pay $40 a year in interest A bond’s yield and its price are inversely related. At face value, a bond’s yield and coupon rate are the same. But if the same bond sells at a premium price of $1,100, its yield is 3.63% , or $40 divided by $1,100 The current yield of a bond is calculated by dividing the annual coupon payment by

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