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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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