Chap 6 Notes - Bond Valuation

Chap 6 Notes - Bond Valuation - \o Iz lo'r Chapter 6: Bond...

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Chapter 6: Bond valuation (ll2') Assignments: a. Questions in section 4 in this handout are assignments by next Tuesday. b. #6-3,5,6,8,11, 19 on page257 -259. c. You may group with the maximum 3 members for your assignments. d. All answers should be neatly written. Otherwise, no points will be given" 1. Bond Valuation When a company (or government) wishes to raise capital from the public on a long-term basis, capital comes in two forms: bonds and stock. Today's topic is the valuation of bpnd. :- * As you can see in the picture in the last page, bonds have the following features. a. Par value (:face value, maturity value, principle amount), denoted by- M b" Interest payment (called coupon payrnent), denoted by INT c. Maturilv date with which the number of period to maturity (denoted by N) is obtained d. Call provision (for corporate bonds and municipal bonds) if applicable. e. etc \o Iz lo'r $*h.r. . ea.s[r.(\ o.,r:-, (€E) of "discounted future values," the p Recall the global valuation formula: 't\re.- o 5** ., \- 6;\t i:c;*^\-.ri -€or 8., ^A: Yk'e- r",;w. o f ,:\''.o -c^,r\"ttz[ f '-\',,T i r'tn.]. {n PU Asset value = c4 , * CF' =+. ..+ Co* ,, (l+r)' (l+r)' (l +r)' You may have noticed that since the above equation is the sum "Asset Value" or "Valuation" is nothing but "PV" or finding PV. You want to utilize the above formula for the valuation of bond!
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Of course the "Asset Value" is "Bond value" in this connection. Then, what is CF and r? If you knew the values of CF's and r in the above, you can solve for bond value. CF is: There are two CF's for bonds Bond value = INT , * JNT ^ +...+ INT .. + M . (l + r)' (l + r)' (l + ro)N (I + r)N Can you simpliff your formula in the above? The oart of NT , * NT = *..-* NT - look famitiar. ' (l + r)' (l + ro)' (l + ru)^ Also, =! - looks familiar, too! ' (l +rr)^ a. Interest (INT) for each period < b. Principal (M) at the maturity f is: r in the previous equation is ra, the market rate of return (or rate of interest) on the bond. You will see soon that ra is equal to the yield to maturity. Remember that ra is determined in the capital market by the interaction between capital supply and capital demand. Since the supply and demand change over time, ra changes over time accordingly. You can observe ra in the Wall Street Journal. Time: CF: If you apply the above INT and M as CF and ra as r, then you have:
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Formula of the present value of bond As vou know. lT NT INT Ud-6+"'+*}- is nothing but the hcsd vahre of m ordhary imuity, with INT as PMT. M '' isthe Fft (l+r)* Because -Trr* ,.Yr-+---+ --ryr- : INf (l+r)' (l+r)' (l+r)' Bond value = N4 , * M, = +...+ NTn =, + M (l+r)' (l+r)z (l+ ro)n (l+r)N INT '-[ l+ro )" rd For calculator, D.{T: PMT M: FV rd = IIY N:N Bond valrc: PV
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A new term: coupon interest rate. Coupon interest rate
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Chap 6 Notes - Bond Valuation - \o Iz lo'r Chapter 6: Bond...

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