Lecture 4 - Bonds

# Lecture 4 - Bonds - Required Reading BONDS Chapter 8,...

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Finance - I (MGCR 341) – Prof. de Mot a BONDS Finance - I (MGCR 341) – Prof. de Mot a 2 Required Reading Chapter 8 , “ Valuing Bonds ” from Berk and De Marzo , Corporate Finance . (Except Section 8.3: Yield Curve and Bond Arbitrage) Finance - I (MGCR 341) – Prof. de Mot a 3 Bond: A security sold by government or corporations to raise money from investors in exchange for a promised future payment. Examples. T-Bills, T-Notes, T-Bonds, Commercial Paper, Corporate Bonds, Municipal Bonds, Mortgage-backed securities etc. Are they important? Fixed income securities account for about 2/3 of the US capital market. Size of World debt market: \$ (US) 13 trillion US accounts for almost 1/2 ; Japan 1/5 Finance - I (MGCR 341) – Prof. de Mot a 4 Bonds: Definitions Maturity ( n ): It is the final repayment date. Coupons Payments ( CNP ): The stated interest payments made on a bond each period. Face Value ( FV ): The notional amount of the bond used to computed the interest. Usually the faced value is repaid at maturity. Coupon Rate: The annual coupon (that is the sum of all the coupon payments during the year) divided by the face value of the bond. Yield to Maturity (YTM): It is the discount rate that sets the present value of the promised bond payments equal to the current market price of the bond. ( Note : Yields are quoted like APRs; the quoted rate is equal to the actual rate per period multiplied by the number of periods in a year . ) Finance - I (MGCR 341) – Prof. de Mot a The World Bond Market is roughly………. the Size of the World Stock Market (fill the gap) a) ONE THIRD b) HALF c) SAME d) TWICE Finance - I (MGCR 341) – Prof. de Mot a World Bond Market

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Finance - I (MGCR 341) – Prof. de Mot a US Bond Market Finance - I (MGCR 341) – Prof. de Mot a Corporate Federal Agency Municipal Treasury Agency MBS Debt Securities Total 2002 10.7 366.4 154.5 16.3 81.8 629.7 2003 12.6 433.5 206.0 18.0 81.7 751.8 2004 14.8 499.0 207.4 18.8 78.8 818.9 2005 16.9 554.5 251.8 16.7 78.8 918.7 2006 22.5 524.7 254.6 16.9 74.4 893.1 2007 25.0 570.2 320.1 16.4 83.0 1,014.7 2008 19.2 553.1 344.9 11.8 104.5 1,033.4 2009 12.3 407.9 299.9 16.8 77.7 814.5 Sources: Federal Reserve Bank of New York, Municipal Securities Rulemaking Board Average Daily Trading Volume in the US Bond Markets (\$Billions) Finance - I (MGCR 341) – Prof. de Mot a 9 Zero-Coupon Bonds Payment Structure of a Zero-Coupon Bond : 0 1 2 ..… n-1 n T ime FV Cash Price and Yield to Maturity of an n-Zero-Coupon Bond: Note: In the above formula “ y is the bond’s YTM (express in the form of its equivalent effective rate ). n y FV P ) 1 ( + = Finance - I (MGCR 341) – Prof. de Mot a 10 Example Consider the following zero-coupon bonds are trading at the prices shown below per \$100 face value. Find their YTM. Maturity 1 Year 2 Years 3 Years Price \$96.62 \$92.45 \$87.63 % 00 . 4 1 45 . 92 100 2 / 1 2 = = YTM % 50 . 3 1 62 . 96 100 1 = = YTM % 50 . 4 1 63 . 87 100 3 / 1 3 = = YTM Finance - I (MGCR 341) – Prof. de Mot a 6164 . 19 2 04382 . 0
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## This note was uploaded on 12/10/2011 for the course MGCR 341 taught by Professor Trainor during the Winter '08 term at McGill.

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Lecture 4 - Bonds - Required Reading BONDS Chapter 8,...

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