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ECON 136: Financial Economics
Section 5 (Sep 25th)
Xing Huang
1
Economics Department, UC Berkeley
1
Bond Pricing
1.1
Review
General formula:
P
=
X
PV
(
payments
)
=
C
(1 +
R
)
1
+
C
(1 +
R
)
2
+
±±±
+
C
(1 +
R
)
T
+
F
(1 +
R
)
T
=
C
R
"
1
²
1
1 +
R
±
T
#
+
F
(1 +
R
)
T
Some Facts:
1. P goes up, R goes down; R goes up, P goes down.
2. C/F = R implies P=F; C/F
>
R implies P
>
F; C/F
<
R implies P
<
F.
3. Longer maturity implies higher sensitivity of price to changes of yield (generally).
Yield curve / term structure of interest rates
1.2
Example
Question 1
There is a coupon bond with $10,000 face value and a 9% coupon rate, which makes semiannual
coupon payments. The maturity of the bond is 7 years. Take the annual interest (or discount) rate
a) Find the price of this coupon bond.
Step 1: Determine the dollar amount of the coupon payments,
C
.
Many coupon bonds pay semiannual payments. For these bonds, it is typical to quote the coupon
rate as 2 times the percentage of the face value which a single coupon payment would consist of.
Thus for our bond,
C
=
$10
;
000
³
9%
2
= $450
You may notice that this is using the arithmetic mean, which we just made a point of saying was
the wrong way of annuualizing a return. This is simply an institutional convention in the way that
1
Thank you all very much !!
1
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View Full Documentcoupon bonds are described, so we just need to remember it and not get confused.
Step 2: Take the annualized interest rate given in the problem and convert it to the appropriate
halfyear interest rate so we can discount the semiannual coupon payments.
1 +
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 Fall '08
 SZEIDL
 Economics

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