Dr. Rodney Boehme
HOW TO VALUE BONDS AND STOCKS
(Assigned problems are 1, 4, 5, 7, 8, 9, 13, 16, 17, 18, 21, 22, 23, 25, 26, 29, 31, and 33.
the Appendix to this chapter).
This notes package contains two Addendums.
Bonds are “Fixed Income” securities, since the cash flows that the bondholder will
receive have been fixed or prespecified in the bond contract.
value of a bond (or any other financial asset)
is equal to the Present Value
of all future
An investor’s actual return on a bond, for any holding period, comes in two forms:
(1) the coupon yield (from the payment of coupon interest)
(2) the capital gain (bond’s change in price)
Zero Coupon Bonds:
bond will pay its stated face or par value
It pays no other future cash flows during its life.
Zeroes are also
The return here comes entirely as a
A zero coupon bond will mature exactly 2 years from today.
sold or issued by the U.S. Treasury and therefore is free of default risk.
The par or
face value is $100.
This bond currently sells for $84.17 in the market.
annual rate of return does the market expect on this bond?
From Chapter 4, we know:
/[1 + r]
We need to solve for
A time line of this bond is shown below:
/[1 + r]
r = [FV
– 1 = [100/84.17]
– 1 = 0.09 or
Actually, anytime we calculate the annual yield
by using the current bond price
and future payments, the
is referred to as the Yield-to-Maturity or YTM.
What will happen to this bond’s price tomorrow if the current market rate of
interest or YTM on this and similar two-year bonds
from 9.0% to 8.8%?
value refers to a
estimate of value – a private estimate of Present Value.
This is not the same
value, which refers to the current price at which a bond or stock is trading for.