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# ch 8 - Chapter 8 Bond Valuation and Risk 1 Bond Valuation...

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1 Chapter 8 Bond Valuation and Risk

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2 Bond Valuation Bond price = the present value of the cash flows generated by the bond n k C k C k C PV ) 1 ( Par .... ) 1 ( ) 1 ( bond of 2 1 + + + + + + = n n r PAR r r PMT BV ) 1 ( ) 1 ( 1 1 + + + - =
3 Example What is the price of a bond with 2 years remaining until maturity whose coupon rate is 5% if the market interest rate is 7%? Assume a \$1,000 par value. 80 . 963 ) 07 . 1 ( 1000 07 . ) 07 . 1 ( 1 1 50 ) 1 ( ) 1 ( 1 1 2 2 = + + + - = + + + - = n n r PAR r r PMT BV 84 . 963 1000 50 % 7 / 2 = = = = = = BV PV FV PMT y i N

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4 Example w/ Semi Annual Payments What is the price of a bond with 2 years remaining until maturity whose coupon rate is 5% if the market interest rate is 7%? Assume a \$1,000 par value and semi annual payments 27 . 963 1000 25 2 / 50 % 5 . 3 2 / % 7 / 4 ) 2 ( 2 = = = = = = = = = BV PV FV PMT y i N
5 Relationship between Coupon Rate, Required Return, and Price If the coupon rate equals the required rate of return, the price of the bond should be equal to par value If the coupon rate of a bond is below the investor’s required rate of return, the present value of the bond should be below par value If the coupon rate of a bond is above the required rate of return, the price of the bond should be above par value

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6 Relationship between Coupon Rate, Required Return, and Price
7 Relationship between Coupon Rate, Required Return, and Price The impact of interest rate movements depends on how the institution’s asset and liability portfolios are structured

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8 Explaining Bond Price Movements The price of the bond is determined by: Risk free rate of return Inflationary expectations Economic growth Money supply Budget deficit Credit risk premium Economic Conditions
9

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ch 8 - Chapter 8 Bond Valuation and Risk 1 Bond Valuation...

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