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Chap2Notes - Valuation of Bonds First Principle Value of...

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9/28/2009 1 Valuation of Bonds First Principle: Value of any financial security = PV of its expected future cash flows To value bonds we need to: Estimate future cash flows: Size (how much) and Timing (when) Discount future cash flows at an appropriate rate: The rate should be appropriate to the risk presented by the security. the yield on alternative investments opportunities with comparable risk. i.e. a measure of opportunity cost of money. The cash flows for a non-callable bond The Expected Cash flow of a (non-callable) bond consist of: head2right Periodic interest payments or coupon payments; Stated as a fixed percentage of the par value – called coupon rate, head2right A fixed face value or par value to be paid at maturity How to Value Bonds Price ( value) of a bond is equal to the present value of the stream of payments from a bond. L 0 C $ 1 C $ 2 C $ 1 - N M C $ $ N Price (Value) of a bond = PV of the annuity of ( semi annual ) coupon Payments + PV of face value 2 2 ) 2 / 1 ( ) 2 / 1 ( 1 1
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