would not have the option of holding it until it matured.
Hence, the yield
to maturity would not be earned.
•
If the current interest rates are well below an outstanding bond
’
s coupon
rate, then a callable bond is likely to be called, and investors will estimate
its expected rate of return as the yield to call (YTC) rather than as the
yield to maturity.
The YTC is calculated by solving the following formula,
(
)
(
)
N
d
t
d
r
1
Price
Call
N
1
t
r
1
INT
b
v
+
=
+
+
=
∑

5
9
A Summary
Bond Selling at . . .Satisfies This Condition
Discount
Coupon Rate < Current Yield < YTM
Premium
Coupon Rate > Current Yield
> YTM
Par Value
Coupon Rate = Current Yield = YTM
10
Bond Price versus Required Yield
•
There is an inverse relationship between bond price and
required yield.
This is because the price of the bond is the
present value of the cash flows.
As the required yield
increases, the present value of the cash flows decreases;
hence the price decreases.
•
When the required yield decrease, the present value of the
cash flows increases and therefore the price of the bond rises.

6
11
Time Path of a Bond
Time
Price
At Maturity
Par Value
Bond traded
at discount
Bond traded
at premium
Price of bond at maturity is equal to
the clean price.
If investor were to
buy the bond at maturity, he would be
entitled to par value and there is no
more coupon payment.
However, the
bond investor bought the bond 6
month prior to maturity will receive
coupon and par value.
12
Relationship between Bond Price & Required Yield
Required Yield
Price

7
14

8
15
Term Structure of Interest Rates (Yield Curve)
•
The relationship between a security yield-to-maturity and its
term to maturity is known to as the maturity structure or term
structure of interest rates.
It is also referred to as the yield
curve.

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- Spring '11
- tohmunheng
- Interest Rates, Interest, Valuation, Yield Curve, YTM, Convertible bond