Ch10_Kim_BKM_INV_7th_S11

# Ch10_Kim_BKM_INV_7th_S11 - Bodie Kane Marcus Essentials of...

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Essentials of Investments Bodie • Kane • Marcus Chapter 10 Bond Prices and Yields

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Essentials of Investments Bodie • Kane • Marcus Bond Pricing T T B T T 1 t t t B ) r 1 ( Value Par ) r 1 ( 1 1 r 1 C P ) r 1 ( Value Par ) r 1 ( C P + - + + - × = + - + + = = where P B = Price of the bond; C t = Interest or coupon payments; T = Number of periods to maturity; r = Discount rate (Required rate of return or YTM) The bond value is the PV of all future expected CFs from the bond, discounted at the appropriate rate that reflects market interest rates and bond-specific characteristics, such as default risk, liquidity, tax attributes, call risk, and so on.
Essentials of Investments Bodie • Kane • Marcus 10-yr, 8% semi-annual coupon payment bond with par value of \$1,000; Required rate of return = 6%. C t = 40 (Semi-annual); Par = 1000; T = 20 periods; r = 3% Example 77 . 148 , 1 \$ P PVIF 1000 PVIFA 40 P ) 03 . 0 1 ( 1000 ) 03 . 0 1 ( 1 1 03 . 0 1 40 P ) 03 . 0 1 ( 1000 ) 03 . 0 1 ( 40 P B 20 %, 3 20 %, 3 B 20 20 B 20 20 1 t t B = × + × = + + + - × = + + + = =

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Essentials of Investments Bodie • Kane • Marcus 10-yr, 8% semi-annual coupon payment bond with par value of \$1,000; Required rate of return = 6%. Step 1 : Press for clearing all time value of money keys of all previously calculated or entered values. Step 2 : Press 1 , repeat until END shows in the display to set one payment per year and to set the annuity payment to the end of period. Step 3 : Input values 3 20 40 1000 - 1148.77 2 nd CLR TVM 2 nd P/Y ENTER 2 nd BGN 2 nd SET 2 nd SET 2 nd SET 2 nd QUIT PV I/Y N CPT PMT FV Bond Pricing: Financial Calculator (BAII+)
Essentials of Investments Bodie • Kane • Marcus Bond Pricing Inverse relationship between Bond Prices and Yields (Required rates of return). Corporate bonds typically issued at par value: When issuing bond, the underwriters must choose a coupon rate that very close to market yields. After the issue, bond prices fluctuate inversely with the market interest rate: Interest rate risk. Keeping all other factors the same, the longer the maturity of the bond, the greater the sensitivity of its price to fluctuations in the interest rate. If the interest rates rise after the purchase of the bond, you will suffer a capital loss: The longer the period for which your money tied up, the greater the loss and the drop in bond price.

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Essentials of Investments Bodie • Kane • Marcus Inverse Relationship Between Bond Prices and Yields Convexity: Increase in interest rates results in price decline that is smaller than the price gain resulting from decrease of equal magnitude in interest rates
Essentials of Investments Bodie • Kane • Marcus Bond Yields: Yield to Maturity The discount rate that makes the PV of a bond’s payments equal to its price. The average rate of return that will be earned on a bond

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Ch10_Kim_BKM_INV_7th_S11 - Bodie Kane Marcus Essentials of...

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