44 5052 5382 5731 6103 total 27012 is its market value

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Unformatted text preview: rary.com. Year Beginning value Ending value 1 2 3 4 5 $729.88 777.32 827.84 881.66 938.97 $ 777.32 827.84 881.66 938.97 1,000.00 Implicit Interest Expense $ 47.44 50.52 53.82 57.31 61.03 Total $270.12 is its market value to a given change in the required return. In other words, short maturities have less interest rate risk than long maturities when all other features (coupon interest rate, par value, and interest payment frequency) are the same. This is because of the mathematics of time value; the present values of short-term cash flows change far less than the present values of longer-term cash flows in response to a given change in the discount rate (required return). EXAMPLE The effect of changing required returns on bonds of differing maturity can be illustrated by using Mills Company’s bond and Figure 6.6. If the required return rises from 10% to 12% (see the dashed line at 8 years), the bond’s value decreases from $1,000 to $901—a 9.9% decrease. If the same change in required return had occurred with only 3 years to maturity (see the dashed line at 3 years), the bond’s value would have dropped to just $952—only a 4.8% decrease. Similar types of responses can be seen for the change in bond value associated with decreases in required returns. The shorter the time to maturity, the less the impact on bond value caused by a given change in the required return. 290 PART 2 Important Financial Concepts Yield to Maturity (YTM) yield to maturity (YTM) The rate of return that investors earn if they buy a bond at a specific price and hold it until maturity. (Assumes that the issuer makes all scheduled interest and principal payments as promised.) EXAMPLE When investors evaluate bonds, they commonly consider yield to maturity (YTM). This is the rate of return that investors earn if they buy the bond at a specific price and hold it until maturity. (The measure assumes, of course, that the issuer makes all scheduled interest and principal payments as promised.) The yield to maturity on a bond with a current price equal to its par v...
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