Security Valuations_Bonds EZ

Security Valuations_Bonds EZ - Valuation of Securities:...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Valuation of Securities: Bonds E. Zivot 2006 R.W. Parks/L.F. Davis 2004 Econ 422: Investment, Capital & Finance University of Washington Last updated: April 11, 2010 Reading • BMA, Chapter 3 http://finance.yahoo.com/bonds http://cxa.marketwatch.com/finra/MarketD ata/Default.aspx • 422Bonds.xls – Illustration of Excel functions for bond pricing E. Zivot 2006 R.W. Parks/L.F. Davis 2004 Review of Roadmap Intertemporal choice Introduction of financial markets—borrowing & lending E. Zivot 2006 R.W. Parks/L.F. Davis 2004 Valuation of intertemporal cash flows – present value Valuation of financial securities providing intertemporal cash flows Choosing among financial securities
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 Bonds • Bonds are a vehicle by which borrowing and lending is facilitated • Bonds are a contract which obligates the issuer (borrower) to make a set of cash payments (interest payments) where the amount and timing is set by the contrac E. Zivot 2006 R.W. Parks/L.F. Davis 2004 contract • The lender (the buyer of the contract) becomes the recipient of these payments • The borrower/issuer is required to return the principal amount borrowed (Face Value) at maturity of the contract Valuing Bonds • Cash flow is contractually specified – Zero coupon bonds – Coupon bonds E. Zivot 2006 R.W. Parks/L.F. Davis 2004 • Determine cash flow from contract terms • Compute present value of cash flow Zero Coupon Bonds • Issue no interest/coupon payments • Referred to as pure discount bonds: they pay a predetermined Face Value amount at a specified date in the future (e.g., $1,000 or $10,000) E. Zivot 2006 R.W. Parks/L.F. Davis 2004 • Purchased at a price today that is below the face value • The increase in value between purchase and redemption represents the interest earned (taxed as ‘phantom’ income)
Background image of page 2
3 Types of Zero Coupon Bonds • US Treasury Bills – 1 month, 3 month, 6 month and 1 year maturities E. Zivot 2006 R.W. Parks/L.F. Davis 2004 • US Treasury Separate Trading of Registered Interest and Principal Securities (STRIPS) – 1 year and Beyond See finance.yahoo.com/bonds for current price and yield data Example: Zero Coupon Bonds • The price is the present value of the future Face Value: P = FV/(1+ r) t • Suppose the government promises to pay you $1,000 in exactly 5 years and assume the relevant discount rate is 5% E. Zivot 2006 R.W. Parks/L.F. Davis 2004 • What is the value or price of this commitment the government is making to you? P = $1,000/(1+0.05) 5 = $783.53 Question: How is the interest rate determined? Bond Price Sensitivity to Interest Rates • 1 year zero coupon bond: P = FV (1+ r ) -1 1 (1 ) dP d FV r dr dr =+ E. Zivot 2006 R.W. Parks/L.F. Davis 2004 21 1 1 1 ) ) (1 ) ) ) % FV r FV r r Pr dP rd r P P −− =− + + + + ⇒= + Δ
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 Example: Bond Price Sensitivity to Interest Rates Bond Maturity Yield Price dP/P dP/P = -T/(1+r) × dr 1 0.01 990.10 $ 0.02 980.39 -0.98% 0.03 970.87 -0.97% E. Zivot 2006 R.W. Parks/L.F. Davis 2004 0.04 961.54 -0.96% 0.05 952.38 -0.95% 0.06 943.40 -0.94% 0.07 934.58 -0.93% 0.08 925.93 0.09 917.43 -0.92% See Excel spreadsheet econ422Bonds.xls on class notes page Bond Price Sensitivity to Interest Rates • T year zero coupon bond: P = FV (1+ r ) - T 11 (1 ) T TT dP d FV r dr dr =+ E. Zivot 2006 R.W. Parks/L.F. Davis 2004
Background image of page 4
Image of page 5
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 12/21/2011 for the course ECON 422 taught by Professor Staff during the Fall '08 term at University of Washington.

Page1 / 24

Security Valuations_Bonds EZ - Valuation of Securities:...

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online