xrhombus N = 40; PV = -1197.93; PMT = 50; FV = 1000 ⇒ I/Y = 4% (yield per 6 months) xrhombus Reported YTM = 4%*2 = 8%
• Timeline: YTM with Semiannual Coupons 0 1 2 40 Suppose a bond with a 10% coupon rate paid semiannually, has a face value of $1000, 20 years to maturity and is selling for $1197.93 6 months 1 year 20 years 50 50 50 PV PV PV = 1197.93 …. 1000 PV PV We already know the 6 month yield has to be less than 5% because the bond is selling at a premium
Bond Pricing Theorems • Bonds of similar risk (and maturity) will be priced to yield about the same return (the same YTM), regardless of the coupon rate • If you know the price of one bond, you can 38 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
The Effect of Time on Bond Prices Five 30 year maturity bonds are issued by the same issuer at different coupon rates at time 0. The interest rate at issuance is 5%. The graph shows what happens to the price of each of those bonds until maturity 30 years later, if the interest rate stay at 5%. 39
Bond Ratings ment Grade 40 Investm Speculative
Factors Affecting Default Risk &Bond Ratings: • Financial performance (for example): – Debt ratio – TIE ratio – Current ratio 41 • Bond contract provisions (for example): – Secured vs. Unsecured debt – Senior vs. Subordinated debt – Guarantee and sinking fund provisions – Debt maturity
Government Bonds • Treasury Securities 1. T-bills – pure discount bonds (zero coupon bonds) with original maturity of one year or less 2. T-notes – coupon debt with original maturity 42 between one and ten years 3. T-bonds - coupon debt with original maturity greater than ten years
Singapore Government Securities 43
• To learn more about Singapore government securities, please visit: – Click on “Publications” Work the Web Example 44 – Click on “Guides” – Click on “A Guide to Singapore Government Securities” for a downloadable pdf guide – See also FAQs under “Publications”
Government Bond vs.Taxable Bond • A taxable bond has a yield of 8% and a non-taxable municipal government bond has a yield of 6% – If you are in a 20% tax bracket, which bond do you prefer? • 8% (1 - 0.2) = 6.4% 45 • The after-tax return on the corporate bond is 6.4%, compared to a 6% return on the municipal – At what tax rate would you be indifferent between the two bonds? • 8% (1 – T) = 6% • T = 25%
Floating Rate Bonds (Floaters) • Here the coupon rate floats depending on some index value – Examples – adjustable rate mortgages and inflation-linked Treasuries 46 • There is less price risk with floating rate bonds – The coupon floats, so it is less likely to differ substantially from the yield-to-maturity • Floating coupon rates may have a “collar” – the rate cannot go above a specified “ceiling” or below a specified “floor”
Other Bond Types • Disaster bonds • Income bonds • Convertible bonds • Put bond 47 • There are many other additional provisions that can be
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- Spring '11