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Unformatted text preview: Chapter 17: Bond Yields and Prices CHAPTER OVERVIEW Chapter 17 concentrates on the issues of bond yields and prices. Most of the calculations concerning bonds are contained in this chapter, thereby allowing Chapter 18 to concentrate on analysis and management issues. The first part of Chapter 17 deals with bond yields and begins with a discussion of interest rates. After briefly considering terminology, the chapter discusses what determines interest rates. Important concepts such as the real rate of interest and the Fisher hypothesis are considered here. The term structure of interest rates is also covered in a concise format, as is the topic of yield spreads (risk premiums). The important concept of yield to maturity is examined in detail. Both conventional bonds and zero-coupon bonds are considered. The issue of the effect of reinvestment rates on realized returns is explained. Yield-to-call and horizon return are also discussed. The next part of the chapter focuses on bond prices by explaining the capitalization of income method of valuation and then applying this methodology to the valuation of bonds. Detailed examples are provided based on semiannual discounting. Bond price changes are considered in detail. This starts with bond price changes over time (price must converge to face value at maturity) and then considers bond price changes as a result of interest rate changes (Malkiel's Theorems). Illustrations on using the calculator where appropriate are included in the discussion. Spreadsheet problems are available at the end of the chapter. Instructors may wish to add to the material in this chapter, or expand on various issues such as bond valuation, yield to maturity, and horizon return analysis. The essential building blocks are presented here, and additional work can easily be added depending upon preferences and time constraints. This is the minimum material that students should be exposed to, but it is also a very reasonable package in terms of what beginners should be expected to master. CHAPTER OBJECTIVES To consider the determination of market interest rates as a natural complement to the discussion of bond yields. To analyze important calculations such as yield to maturity, yield to call, and realized compound yield. To explain how bond prices are calculated. To consider how bond prices change over time as interest rates change. POINTS TO NOTE ABOUT CHAPTER 17 Exhibits, Figures and Tables Figure 17-1 illustrates yield curves at selected points in time. Upward sloping, flattened, and downward curves are shown. Figure 17-2 shows yield spreads for a few years between 10-year Treasuries and Baa corporate bonds. The spread widened significantly in late 2008....
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This note was uploaded on 02/13/2012 for the course FINA 3480 taught by Professor Moore during the Spring '11 term at Toledo.
- Spring '11