Class 11 Completed

# 07 1 1 60 1 1 1 10 10 n n b r f r r c p 6 current

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) 07 . 1 ( 1 60 ) 1 ( ) 1 ( 1 * 10 10 = + = + ⎥ ⎦ ⎤ ⎢ ⎣ ⎡ − = + + ⎥ ⎦ ⎤ ⎢ ⎣ ⎡ + = n n B r F r r C P

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6 Current Yield K The current yield is defined as the annual coupon payment divided by the current price. K The current yield measures cash income provided by the bond as a percentage of the bond s price. K The current yield ignores price appreciation (for discount bonds) and price depreciation (for premium bonds). Current yield in previous example: current yield = annual coupon payment price of bond current yield = \$120 \$929.76 = 12.9066%
7 Capital Gains and Losses K Think about investors who hold gold or zero coupon bonds. Any return on these investments comes through changes in prices over time. K Return that result from price changes are called a capital gains or losses. K Changes in the prices of coupon bonds also lead to capital gains or losses. price old price old price new loss gain price old price new loss gain = = / % / \$\$

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8 Example: Capital Gain K An investor buys a zero coupon bond for \$933 and holds it until maturity, when it s value is \$1,000. K Then the investor s \$\$ capital gain is \$67. K His percentage gain is equal to: % gain = 1,000 ! 933 933 = 7.1811%
Discount Bonds and Premium Bonds K A bond that trades below par value is called a discount bond. The return on a discount bond consists of the coupon payment and price appreciation (capital gains) over time. K A bond that trades above par value is called a premium bond. Return on a premium bond consists of coupon payment and (built-in) price depreciation (capital losses) over time. 9

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10 Example: Built-in Capital Gain for Discount Bond K Consider a bond with a face value of \$1,000. Coupon payments are annual and the coupon rate is 5% with 5 years to maturity. K The market interest rate is 6% for similar bonds K The price of the bond is: K Now suppose one year later, the market rate is still 6%. K What is the price of the bond one year later?

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• Spring '10
• E.Fowler

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