Chapter6 - FIN3100 Chapter 6 Bond Valuation Learning...

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FIN3100: Chapter 6 Bond Valuation
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Learning Objectives Understand basic bond terminology and apply the time value of money equation in pricing bonds. Understand the difference between annual, semiannual, and zero-coupon bonds. Understand the relationship between the coupon rate and the yield to maturity. Consider bond ratings and why ratings affect bond prices. Review common features of bonds.
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Definitions Bond – debt issued for more than 1 year Par value (face value) – repaid at end of loan, assume $1,000 if not specified Coupon rate - % payment Coupon payment - $ payment Maturity date Yield or Yield to maturity – market’s required rate
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Cash Flows from a Bond Provide periodic interest income – annuity series Return of the principal amount at maturity – future lump sum Combination of present value of an annuity and of a lump sum Bond Value = PV of coupons + PV of par Bond Value = PV annuity + PV of lump sum Remember, as interest rates increase the PVs decrease. So, as interest rates increase, bond prices decrease and vice versa.
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Key Components of a Corporate Bond Consider the following price quote for a bond: Current Issue Price Coupon(%) Maturity YTM% Yld. Rating Hertz Hertz 91.50 6.35 15-Jun-2010 15-Jun-2010 15.438 15.438 6.94 6.94 B Price = 91.5% of $1000 = $915 $915 Annual coupon = 6.35% *1000 = $63.50 $63.50 Maturity date = June 15, 2010 June 15, 2010 If bought and held to maturity yield = 15.438% 15.438% Current Yield = $ Coupon/Price = $63.5/$915 = 6.94% 6.94%
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The Bond Pricing Equation n r) (1 Value Face r n r) (1 1 1- PMT Value Bond + + + =
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Valuing a Discount Bond with Annual Coupons Consider a bond with a coupon rate of 10% and coupons paid annually. The par value is $1,000 and the bond has 5 years to maturity. The yield to maturity is 11%. What is the value of the bond?
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