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Unformatted text preview: erm bonds have more price risk than short-term bonds
Low coupon rate bonds have more price risk than high coupon
rate Reinvestment Rate Risk Uncertainty concerning rates at which cash flows can be
Short-term bonds have more reinvestment rate risk than longterm bonds
High coupon rate bonds have more reinvestment rate risk than
low coupon rate bonds
low 12 Figure 7.2 13 Computing Yield-to-maturity Yield-to-maturity is the rate implied by the
current bond price
Finding the YTM requires trial and error if you do
not have a financial calculator and is similar to
the process for finding r with an annuity
If you have a financial calculator, enter N, PV,
PMT, and FV, remembering the sign convention
(PMT and FV need to have the same sign, PV
the opposite sign)
the 14 YTM with Annual Coupons Consider a bond with a 10% annual coupon rate,
15 years to maturity and a par value of $1,000.
The current price is $928.09.
The Will the yield be more or less than 10%?
N = 15; PV = -928.09; FV = 1,000; PMT = 100
CPT I/Y = 11% 15 YTM with Semiannual Coupons Suppose a bond with a 10% coupon rate and
semiannual coupons, has a face value of
$1,000, 20 years to maturity and is selling for
$1,197.93. Is the YTM more or less than 10%?
What is the semiannual coupon payment?
How many periods are there?
N = 40; PV = -1,197.93; PMT = 50; FV = 1,000; CPT
I/Y = 4% (Is this the YTM?)
YTM = 4%*2 = 8% 16 Table 7.1 17 Current Yield vs. Yield to Maturity Current Yield = annual coupon / price
Yield to maturity = current yield + capital gains yield
Example: 10% coupon bond, with semiannual coupons,
face value of 1,000, 20 years to maturity, $1,197.93 price
face Current yield = 100 / 1,197.93 = .0835 = 8.35%
Price in one year, assuming no change in YTM = 1,193.68
Capital gain yield = (1,193.68 – 1,197.93) / 1,197.93 = -.0035 =
YTM = 8.35 - .35 = 8%, which the same YTM computed earlier 18 Bond Pricing Theorems Bonds of similar risk (and maturity) will be priced
to yield about the same return, regardless of the
If you know the price of one bond, you can
estimate its YTM and use that to find the price of
the second bond
This is a useful concept that can be transferred
to valuing assets other than bonds
to 19 Bond Prices with a Spreadsheet There is a specific formula for finding bond
prices on a spreadsheet
Settlement and maturity need to be actual dates
The redemption and Pr need to be input as % of par value Click on the Excel icon for an example 20 Differences Between Debt and
Equity Debt Not an ownership interest
Creditors do not have
Interest is considered a
cost of doing business
and is tax deductible
Creditors have legal
recourse if interest or
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