Exam 2 note sheet - Chapter 7) Interest rates and bond...

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Bond Value = PV of coupons + PV of par T = time to maturity (N) r = yield to maturity (I/Y) C = annual coupon (PMT) F = par value (FV) Chapter 7) Interest rates and bond valuation. Par value or face value - Principal, amount repaid at the end of the term. Coupon (payment) - The stated interest payment made on a bond Coupon rate - The annual coupon divided by the face value of a bond Maturity date - Specified date on which the principal amount of a bond is paid Time to maturity - The number of years until the face value is paid Yield or Yield to maturity - The interest rate required in the market on a bond Discount Bond - a bond that sells for less than its par/face value; YTM is greater than coupon rate. Premium Bond - a bond that sells for more that its par/face value; YTM is less than the coupon rate. Interest Rate risk - the risk that arises for bond owners from fluctuation interest rates. Real rate of interest - percent change in purchasing power Nominal rate of interest - quoted rate of interest, percent change in dollars Inflation - percent change in price level Fisher Effect - defines the relationship between real rates, nominal rates and inflation. Petty, Co. issues $1,000 par bonds with 20 years to maturity. The annual coupon is $110. Similar bonds have a yield to maturity of 11%. o PV of coupons=110[1-1/(1.11)20]/.11 o =875.97 o PV of face value=1,000/(1.11)20=124.03 o Bond value=875.97+124.03=1,000 o Since the coupon rate and the yield are the same, the price should equal face value. Discount Bond - Suppose the YTM on bonds similar to that of Petty Co. is 13% instead of 11%. What is the bond price? (same for premium bond) Using the formula: o Bond Value = PV of annuity + PV of lump sum o = 110[1 – 1/(1.13)20] / .13 + 1,000 / (1.13)20 o = 772.72+86.78=859.50 Interest rate risk All other things being equal: o Longer time 2 maturity, greater interest rate risk o Lower the coupon rate, greater interest rate risk Consider a bond with a 10% annual coupon rate, 15 years to maturity and a par value of $1000. The current price is $928.09. Will the yield be more or less than 10%?
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This note was uploaded on 04/07/2008 for the course FIN 325 taught by Professor Na during the Spring '07 term at Washington State University .

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Exam 2 note sheet - Chapter 7) Interest rates and bond...

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