Notes on Bond Valuation

Notes on Bond Valuation - Notes on Bond Valuation A bond is...

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Notes on Bond Valuation A bond is the instrument used for term borrowings in the public markets. A bond is governed by a detailed legal agreement (indenture) which sets out the rights and obligations of the issuer (borrower) and the investor or holder (lender). Included in the agreement are financial and other covenants, breach of which result in default under the agreement. Such default can result in acceleration of payments and other remedies. A bond is a negotiable instrument and bonds are traded actively. In the US, bonds have to be registered in the name of the holder. Outside of the US, particularly in Europe, many bonds are bearer bonds which means that they are not registered in any name and the bearer (holder) is presumed to have legal title to it. There are many different types and flavors of bonds. This paper focuses on two types; the zero coupon bond and the straight coupon bond. It will focus on bonds that have no possibility of default. The bonds discussed have a face value of $1,000 with annual coupon payments. Zero Coupon Bond A zero coupon bond is issued at a discount to face value and is repaid in a single payment at maturity equal to the face value. For an investor, the cash flows on a 5 year zero coupon bond look like this: t = 0 t = 1 t = 2 t = 3 t = 4 t = 5 -Price Face Value = $1,000 The price of such a bond is computed as follows: Price (PV) = Face Value (Future Value, FV)/(1 + r) 5 //home/vdimitrov/18633/442894b5342c592f960f8afcc78df9a8a520a2d6.doc 1 of 5
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r = (FV/PV) 1/5 - 1 In the marketplace, the price is observed and, knowing the face value, r, the yield to maturity can be calculated. r
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Notes on Bond Valuation - Notes on Bond Valuation A bond is...

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