MGMT_130_Lecture_6

MGMT_130_Lecture_6 - MGMT 130 Lecture 6 Bonds and Bond...

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MGMT 130 Lecture 6 Bonds and Bond Valuation
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What is a Bond? A bond is a certificate (a “note” or “bill”) that signifies an obligation to pay a specified amount over a specified period of time. The structure of the payments gives rise to different types of bonds: pure discount bonds, coupon bonds, or consols. Defined by: issuer; coupon; maturity; face value; type of bond
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Discount Bonds A discount bond is a promise to pay a certain amount on a certain date. There are no coupon payments in the interim. These are also called “zeros” or zero coupon bonds. The payment is due on the maturity date, when the bond is redeemed for face value (or par ). The bonds are issued at a price below face value, or at a discount to par. To value these bonds, we simply need to determine the present value of the single cash payment.
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Valuing a Discount Bond Suppose the US Government issues a $1 million zero coupon obligation due in 20 years. Prevailing interest rates at the 20 year horizon are 5%. So, the present value of this bond is $376,889. What if the bond was issued with prevailing rates at 4%? Bond value is $456,386. ( 29 T r F PV + = 1
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Coupon Bonds Coupon Bonds offer a final repayment at maturity, but also regular coupon payments. These coupon payments come generally every six months and are fixed for the life of the bond. To value these bonds, we again simply compute the present value of the discounted future cash flows. ( 29 ( 29 ( 29 ( 29 T T r F r C r C r C PV + + + + + + + + = 1 1 ... 1 1 2
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Suppose our previous 5% US Treasury was instead a coupon bond. What is the value? Year
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MGMT_130_Lecture_6 - MGMT 130 Lecture 6 Bonds and Bond...

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