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Lecture 7 Ch 8 UGBA 103 2011

Lecture 7 Ch 8 UGBA 103 2011 - Chapter 8 Valuing Bonds Bond...

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Chapter 8 Valuing Bonds
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Bond Terminology Bond Certificate §੿ States the terms of the bond Maturity Date §੿ Final repayment date Term §੿ The time remaining until the repayment date Coupon §੿ Promised interest payments
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Bond Terminology Face Value §੿ Notional amount used to compute the interest payments Coupon Rate §੿ Determines the amount of each coupon payment, expressed as an APR Coupon Payment
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Zero-Coupon Bonds Zero-Coupon Bond §੿ Does not make coupon payments §੿ Always sells at a discount (a price lower than face value), so they are also called pure discount bonds §੿ Treasury Bills are U.S. government zero-coupon bonds with a maturity of up to one year.
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Zero-Coupon Bonds Suppose that a one-year, risk-free, zero-coupon bond with a $100,000 face value has an initial price of $96,618.36. The cash flows would be: §੿ Although the bond pays no “interest,” your compensation is the difference between the initial price and the face value.
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Yield to Maturity for Zero-Coupon Bonds §੿ For the one-year (i.e., n = 1) zero coupon bond: §੿ Thus, the YTM is 3.5%.
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Yield to Maturity for Zero-Coupon Bonds Yield to Maturity of an n -Year Zero-Coupon Bond §੿ Note that you can calculate the yield to maturity of an n-year zero-coupon bond with an ordinary (not financial, not graphing) calculator.
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Zero-Coupon Bonds Risk-Free Interest Rates §੿ A default-free zero-coupon bond that matures on date n provides a risk-free return over the same period. Thus, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity on such a bond. §੿ Risk-Free Interest Rate with Maturity n
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Risk-Free Interest Rates Spot Interest Rate §੿ Another term for a default-free, zero-coupon yield Zero-Coupon Yield Curve §੿ A plot of the yield of risk-free zero-coupon bonds as a function of the bond’s maturity date
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Coupon Bonds Coupon Bonds §੿ Pay face value at maturity §੿
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