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Unformatted text preview: 71Chapter 7Interest Rates and Bond ValuationChapter Outline•Bonds and Bond Valuation•Bond feature •Some Different Types of Bonds•Bond Markets•Inflation and Interest Rates•Determinants of Bond Yields72Key Concepts and Skills•Know the important bond features and bond types•Understand bond values and why they fluctuate and the determinants of bond yields•Understand bond ratings and what they mean•Understand the impact of inflation on interest rates•Understand the term structure of interest rates73Bond DefinitionsBond – a debt security issued by a company for borrowing money with the following features:–Par value (face value)–Coupon rate–Coupon payment–Maturity of time period–Yield or Yield to maturity74The Bond Pricing EquationA.2Tabler)(11A.3Tablerr)(111CValueBondtt+++=FV75FV  Par value (face value)C  Coupon payment = FV * coupon ratet  Maturity (or number of periods)r  Yield to maturityBond Value = PV ( Coupon Annuity) + PV (Par Value)The Bond Pricing EquationA.2Tabler)(11ValueBondt+=FV76FV  Par value (face value)t  Maturity (or number of periods)r  Yield to maturityCurrent yield = Coupon / PriceZero Coupon Bound: C=0Premium Bound (Coupon rate > yield to maturity)•A bond has a 10% annual coupon and a face value of $1000, 20 years to maturity, and the yield to maturity is 8%. What is the price of this bond?•FV = 1000, t=20 r=8% coupon rate = 10%Coupon payment = 1000*10% =100Annuity discount factor (t=20, r=8%) = 9.8181 (Table A.3,pA6) PV (C annuity) = 100 * 9.8181 = 981.81Discount factor (t=20, r=8%) = 0.2145 (Table A.2, pA4)PV (Par value) = 1000 * 0.2145 = 214.5Bound value = 981.81 + 214.5 = 1196.31•Key point: Premium bound: Price (or PV) > Par or Face Value77Discount Bond(coupon rate < yield to maturity)A bond with an annual coupon rate of 8%. The par value is $1,000, and the bond has 5 years to maturity. The yield to maturity is 10%. What is the value of the bond?FV =1000, coupon rate = 8%, r=10%, t=5Coupon payment = 1000*8% = 80Annuity discount factor (10%, t=5)=3.7908 (Table A.3, pA6)PV (C Annuity) = 80 * 3.7908 = 303.26Discount factor (10%, t=5) = 0.6209 (Table A.2, p A4)PV (Par Value) = 1000 * 0.6209= 620.9Bound value = 303.26 + 620.9 = 924.16Key point: Price (or PV) < Par or Face Value 78Bond PricesRelationship Between Coupon and Yield•If YTM > coupon rate, then par value > bond price–Why? The discount provides yield above coupon rate–Price below par value, called a discount bond•If YTM < coupon rate, then par value < bond price–Why? Higher coupon rate causes value above par–Price above par value, called a premium bond•If YTM = coupon rate, then par value = bond price79Summary Table710Bond Prices with a Spreadsheet•There is a specific formula for finding bond prices on a spreadsheet–PRICE(Settlement,Maturity,Rate,Yld,Redemption, Frequency,Basis)–YIELD(Settlement,Maturity,Rate,Pr,Redemption, Frequency,Basis)–Settlement and maturity need to be actual dates...
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This note was uploaded on 02/06/2012 for the course FINANCE 390 taught by Professor Zhang during the Spring '11 term at Metro State.
 Spring '11
 Zhang
 Finance, Interest, Interest Rate, Valuation

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