Class5_ValuingBonds_15-Sep_04(6slides) - Todays plan Class...

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1 Class 5: Valuing Bonds 2 Today’s plan ± Bonds - what are they? ± Zero coupon bonds ± Eurobonds ± Compounding revisited ² fractional periods ² conventions ± Bond Valuation ± Yield to Maturity (YTM) ± Term Structure of Interest Rates ± Interest Rates and Inflation (Fisher Effect) 3 What is a bond? ± A bond is a financial instrument (contract) Main features of a bond: ± A bond promises to repay a fixed amount ( face amount/par value ) on a specific date in the future ( maturity ) ± Some bonds make interim payments of interest: ² for fixed rate bonds, the amounts of the payments ( coupon payments ) and the dates of the payments are known in advance ² for floating rate bonds, the amounts of the payments is not known in advance but the dates of the payments are known in advance 4 What is a bond? (2) ± A bond also has (legal) rights attached to it: ² if the borrower doesn’t make the required payments, bondholders can force bankruptcy proceedings ² in the event of bankruptcy, bond holders get paid before equity holders 5 What is a bond? ± A fixed-income security is a claim on a specified periodic stream of cash payments ± The bond is the basic fixed-income security: ² It is a borrowing arrangement under which the borrower agrees to make payments of interest and principal , on specific dates , to the holders of the bond ² Typical issuers of bonds: ³ Federal Government: Treasury Bonds ³ Corporations: Corporate Bonds ³ States & Cities: Municipal Bonds ³ Foreign Governments & Corporations: Foreign Bonds 6 What is a bond? ± Alternative (but equivalent) definition: ² It is a security obligating the issuer (seller) to make specific payments of interest and principal to the bondholder at specified dates , over a period of time
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2 7 Roadmap ± We want to learn how to price bonds ² The simplest among financial assets, but also among the most ubiquitous and fascinating ³ Federal, State, and Local authorities routinely issue bonds to finance their deficit ³ Corporations also issue bonds to fund their investments ± We will focus on ² Major bond features ² Bond valuation ² Different types of bonds ² What affects bond prices: interest rates & inflation 8 Treasury bonds The Wall Street Journal ( ) 9 Coupon?? ¾ Confederate States of America War Bond 1864 10 Zero coupon bonds ± Zero coupon bonds are the simplest type of bond ± We have the machinery to value these (easily) ! ± You buy a zero coupon bond today (cash outflow) and you get paid back the bond’s face value at some point in the future ( called the bond’s maturity ) ± How much is a 10-yr zero coupon bond worth today if the face value is $1,000 and the effective annual rate is 8% ? $1,000 PV = ??? yr 10 19 . 463 $ ) 08 . 1 ( 000 , 1 $ PV 10 = = 11 Eurobonds ± Eurobonds: U.S. and foreign companies can raise money across the pond ( can be USD, EUR, GBP, etc.) ± Investors buy the bond today, receive an annual coupon payment plus the face value at maturity ± The coupon is a percentage of the face value ± We have the machinery to value Eurobonds ±
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This note was uploaded on 12/06/2011 for the course UGBA 103 taught by Professor Berk during the Fall '07 term at University of California, Berkeley.

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Class5_ValuingBonds_15-Sep_04(6slides) - Todays plan Class...

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