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chapter 5

# chapter 5 - Chapter 5 Valuing bonds COPYRIGHTZHULI 1...

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COPYRIGHT©ZHULI 2 Objectives 1. Distinguish among a bond’s coupon rate, current yield, and yield to maturity 2. Find the market price of a bond given its yield to maturity, find a bond’s yield given its price, and demonstrate why prices and yields vary inversely 3. Show why bonds exhibit interest rate risk 4. Understand why investors pay attention to bond ratings and demand a higher interest rate for bonds with low ratings
COPYRIGHT©ZHULI 3 Content Bond characteristics Interest rates and bond prices Current yield and yield to maturity Bond rates of return The yield curve Corporate bonds and the risk of default

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COPYRIGHT©ZHULI 4 Bond : security that obligates the issuer to make specified payments to the bondholder C oupon : the interest payments paid to the bondholder Face value or principal : payment at maturity of the bond. Also called par value or maturity value Coupon rate : annual interest payment as a percentage of face value
COPYRIGHT©ZHULI 5 Consider a U.S. Treasury bond as an example. Several years ago, the U.S. Treasury raised money by selling 5.5% coupon, 2008 maturity Treasury bonds. Each bond has a face value of \$1000. Suppose that in 2005 you decided to buy the 5.5% coupon bonds maturing in 2008. If you planned to hold the bond until maturity, the cash flows would be as follows:

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COPYRIGHT©ZHULI 6 Coupon payment Face value Bond prices are quoted in 32nds rather than decimals e.g. 105:32 means that the price is 105 and 23/32, or 105.719%, therefore each bond costs \$1057.19
COPYRIGHT©ZHULI 7 Bond: a° Coupon: a° Face value or par value : a ° Principal: a° Maturity value: a° ° Coupon rate: a° ° °

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COPYRIGHT©ZHULI 8 Content Bond characteristics Interest rates and bond prices Current yield and yield to maturity Bond rates of return The yield curve Corporate bonds and the risk of default
COPYRIGHT©ZHULI 9 How much would you have been willing to pay for the bond? The value of a security is the present value of the cash flows it will pay to its owners.

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