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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 how to calculate bond prices and why prices fluctuate Understand bond ratings Understand the impact of inflation on interest rates Understand the Term Structure of Interest Rates and the determinants of bond yields Understand 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 thirty 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 2019 but we’ll call it a ten year. 3. Structure Coupon, Zero, Amortizing

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6 A Bond is Defined (or Identified) by: 1. Coupon Rate (if applicable) 7% Semi-Annual, 10% Annual… 2. Bond Features Callable, Convertible... (we’ll talk about this later) 3. Rating Rating agencies (S&P, Moodys, Fitch…) issue public rating. BBB or higher are Investment Grade BB or lower are N on-Investment Grade (junk) Example: GE 5.125 of 2028 (“five and an eighth of 28”) GE corp bond. Matures in 2028. Pays a 5.125% S-A coupon. AAA rated
7 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 payments of \$100, discounted at 10%: PV = 100/(1.1) + 100/(1.1) 2 + 100/(1.1) 3 + … + 100/(1.1) 30 = \$942.69 N = 30 I/YR = 10 PMT = 100 PV = -942.69 1. One payment of \$1,000 in thirty years PV = 1,000/(1.1) 30 = \$57.31 N = 30 I/YR = 10 FV = 1000 PV = -57.31 Or both at the same time: Total Price: = \$942.69 + \$57.31 = \$1,000 N = 30 I/YR = 10 PMT = 100 FV = 1000 PV = -1000 Equal to the Face Value or Par Value

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8 Calculate the price of the bond: Same bond with a different YTMs: Why might the bond’s YTM change? The issuer’s credit rating has changed All rates have changed 30 year \$1,000 Face or Par Value, 10% annual coupon 8% required rate (YTM = 8%) N = 30 I/YR = 8 PMT = 100 FV = 1000 PV = -1225 Price = \$1,225 Great than the Face Value or Par Value (Premium) 30 year \$1,000 Face or Par Value, 10% annual coupon 12% required rate (YTM = 8%) N = 30 I/YR = 8 PMT = 100 FV = 1000 PV = -893 Price = \$839 Less than the Face Value or Par Value (Premium)
9 Important thing about a bond’s price: If YTM = Coupon Rate Price = Par N = 30 I/YR = 10 PMT = 100 FV = 1000 PV = -1000 If YTM > Coupon Rate Price < Par Priced at a “discount” N = 30 I/YR = 12 PMT = 100 FV = 1000 PV = -839 If YTM < Coupon Rate Price > Par Priced at a “premium” Why?

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10 Bonds are Issued at Par
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BCOR 2200 Chapter 6 - Chapter 6 Interest Rates and Bond...

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