Chap007 Updated

Chap007 Updated - Chapter 7 Bond Prices Bond Definitions...

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Chapter 7 Bond Prices
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Bond Definitions Bond Par value (face value) Coupon rate Coupon payment Maturity date Yield or Yield to maturity 7-2
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Present Value of Cash Flows as Rates Change Bond Value = PV of coupons + PV of par Bond Value = PV of annuity + PV of lump sum As interest rates increase, present values decrease So, as interest rates increase, bond prices decrease and vice versa 7-3
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Graphical Relationship Between Price and Yield-to-maturity (YTM) 600 700 800 900 1000 1100 1200 1300 1400 1500 0% 2% 4% 6% 8% 10% 12% 14% Bond Price Yield-to-maturity (YTM) 7-4
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Bond Prices: Relationship Between Coupon and Yield If YTM = coupon rate, then par value = bond price If YTM > coupon rate, then par value > bond price Why? The discount provides yield above coupon rate Price below par value, called a discount bond If YTM < coupon rate, then par value < bond price Why? Higher coupon rate causes value above par Price above par value, called a premium bond 7-5
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Interest Rate Risk Price Risk Change in price due to changes in interest rates Long-term bonds have more price risk than short-term bonds Low coupon rate bonds have more price risk than high coupon rate bonds Reinvestment Rate Risk Uncertainty concerning rates at which cash flows can be reinvested Short-term bonds have more reinvestment rate risk than long-term bonds High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds 7-6
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Figure 7.2 7-7
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Computing Yield to Maturity Yield to Maturity (YTM) is the rate implied by the current bond price Finding the YTM requires trial and error if you do not have a financial calculator and is similar to the process for finding r with an annuity If you have a financial calculator, enter N, PV, PMT, and FV, remembering the sign convention (PMT and FV need to have the same sign, PV the opposite sign) 7-8
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YTM with Annual Coupons Consider a bond with a 10% annual coupon rate, 15 years to maturity and a par value of $1,000. The current price is $928.09. Will the yield be more or less than 10%? N = 15; PV = -928.09; FV = 1,000; PMT = 100 CPT I/Y = 11% 7-9
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Coupons Suppose a bond with a 10% coupon rate and semiannual coupons, has a face value of $1,000, 20 years to maturity and is selling for $1,197.93. Is the YTM more or less than 10%? What is the semiannual coupon payment? How many periods are there?
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Chap007 Updated - Chapter 7 Bond Prices Bond Definitions...

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