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Chap3Notes

# Chap3Notes - Measures of Bond Yields Yield to Maturity...

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1 Measures of Bond Yields – Yield to Maturity Yield to Maturity: defined as the discount rate That makes the present value of the future cash flows of A bond equal to its price today. The yield to maturity is measure similar to the IRR. To calculate the YTM , we solve the formula for computing the price of a bond, for the interest rate. ) y + (1 C + . . . + ) y + (1 C + ) y + (1 C + ) y + (1 C = P N N 2 2 1 1 B 3 3 1 1 (1 ) (1 ) B n n C M P y y y = - + + + Yield to Maturity – An example Suppose, you can buy a 15 year, 8% Semi-annual coupon bond for P B = \$1,125.00. The YTM is: barb4right y = 3.33% The annual YTM, or the Bond Equivalent Yield = 3.33% x 2 = 6.67%. Effective Annual Rate = (1+y) m – 1 = (1+.033) 2 – 1 = 6.78% 15 2 15 2 40 1 1,000 1,125 1 /2 (1 /2) (1 /2) B x x P y y y = = - + + + Yield to Maturity – Underlying assumption When we use yield to maturity as a measure of total return, we in effect make two implicit assumptions: We assume that the Bond will be held to maturity, We also assume that we shall be able to reinvest all coupons at the yield to maturity. Put another way (a) that the Term Structure of interest rates is currently flat (b) that it will remain flat at the current level over the life of the bond Neither assumption may be valid !!

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2 Yield calculation in Excel There are two Excel functions: 1. RATE ( nper, pmt , pv, fv, type ) 2. YIELD ( settl,t , mat. , rate , pr , redem , freq , basis) Settlement = the security's settlement date. Maturity = the security's maturity date. Rate = the security's annual coupon rate.
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