Chap005(WW-FIN357)NT

Chap005(WW-FIN357)NT - Chapter 5 Interest Rates and Bond...

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Unformatted text preview: Chapter 5 Interest Rates and Bond Valuation 5-2 Chapter Outline 5.1 Bonds and Bond Valuation 5.2 Bond Features 5.3 Bond Ratings 5.4 Different Types of Bonds 5.5 Bond Markets 5.6 Inflation and Interest Rates 5.7 Determinants of Bond Yields 5-3 Key Concepts and Skills • Know important bond features and types • Understand bond values and fluctuations • Understand what bond ratings mean • Understand the effect of inflation on market interest rates • Understand the term structure of interest rates and the determinants of bond yields 5-4 5.1 Bonds and Bond Valuation • A bond is a legally binding contract between a borrower and a lender that specifies : – Par (face) value ( principal amount of loan ) – Coupon rate – Coupon payment – Maturity Date 5-5 Bond Valuation • Primary Financial Principle: – Value of financial securities = PV of expected future cash flows • Bond value is determined by the PV of coupon payments and par value. • Current bond values are inversely related to interest rates 5-6 The Bond-Pricing Equation T T r) (1 F r r) (1 1- 1 C Value Bond + + + = 5-7 Bond Example • A U.S. government bond with a 6 3/8% coupon that expires in December 2009. – The Par Value of the bond is $1,000. – Coupon payments are made semi-annually (June 30 and December 31). – coupon rate is 6 3/8%, the payment is $31.875. 05 / 1 / 1 875 . 31 $ 05 / 30 / 6 875 . 31 $ 05 / 31 / 12 875 . 31 $ 09 / 30 / 6 875 . 031 , 1 $ 09 / 31 / 12 5-8 Bond Example • On January 1, 2005, the required yield is 5%. • The size and timing of the cash flows are: 05 / 1 / 1 875 . 31 $ 05 / 30 / 6 875 . 31 $ 05 / 31 / 12 875 . 31 $ 09 / 30 / 6 875 . 031 , 1 $ 09 / 31 / 12 17 . 060 , 1 $ ) 025 . 1 ( 000 , 1 $ ) 025 . 1 ( 1 1 2 05 . 875 . 31 $ 10 10 = + - = PV 5-9 Bond Example: Calculator PMT I/Y FV PV N PV 31.875 = 2.5 1,000 – 1,060.17 10 1,000×0.06375 2 Find the present value (January 1, 2005) of a 6 3/8% coupon bond with semi-annual payments and a maturity date of December 31, 2009, if the YTM is 5%. 5-10 Bond Example • Now assume that the required yield is 11%. • How does this change the bond’s price? 05 / 1 / 1 875 . 31 $ 05 / 30 / 6 875 . 31 $ 05 / 31 / 12 875 . 31 $ 09 / 30 / 6 875 . 031 , 1 $ 09 / 31 / 12 69 . 825 $ ) 055 . 1 ( 000 , 1 $ ) 055 . 1 ( 1 1 2 11 . 875 . 31 $ 10 10 = + - = PV 5-11 YTM and Bond Value 800 1000 1100 1200 1300 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1 Discount Rate Bond Value 6 3/8 When the YTM < coupon, the bond trades at a premium. When the YTM = coupon, the bond trades at par. When the YTM > coupon, the bond trades at a discount. 5-12 Bond Concepts • Bond prices and market interest rates move in opposite directions....
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This note was uploaded on 10/16/2011 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas.

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Chap005(WW-FIN357)NT - Chapter 5 Interest Rates and Bond...

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