Year payment pv of the payment 05 3 1 3 15 3 2 103

Info icon This preview shows pages 25–30. Sign up to view the full content.

Year Payment PV of the payment 0.5 3 $ 1 3 $ 1.5 3 $ 2 103 $ Sum $ A 0 = A t e Rt
Image of page 25

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

Bond pricing: Example Fin330 26 l Recall that the PV of investment with continuous compounding is l The flow of funds for an investor: l Theoretical price of the bond is $98.39. Year Payment PV of the payment 0.5 3 $ 1 3 $ 1.5 3 $ 2 103 $ Sum $ 98.39 A 0 = A t e Rt 3 e 0.05 × 0.5 3 e 0.058 × 1.0 3 e 0.064 × 1.5 103 e 0.068 × 2.0
Image of page 26
Bond pricing: arbitrage l In the previous example: l What could investors do if the market price of the bond were above its theoretical price? Answer: l What could investors do if the market price of the bond were below its theoretical price? Answer: Fin330 27
Image of page 27

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

Bond’s Yield l A bond’s yield is a single discount rate that, when applied to all cash flows, gives the bond’s value equal to the bond’s price. l In the example above: What single yield y should we apply to discount the payments, so that their present value equals to the bonds price of $98.39? Answer: y=6.76% (check this!). Fin330 28 Year Payment PV of the payment 0.5 3 $ 1 3 $ 1.5 3 $ 2 103 $ Sum $ 98.39 3 e y × 0.5 3 e y × 1.0 3 e y × 1.5 103 e y × 2.0
Image of page 28
Term structure of interest rates l The term structure of interest rates ( yield curve ) is the relationship between bond yields and different terms or maturities. l YTM is the internal rate of return of an investment in the bond with a given maturity made at the observed price. l Bond prices are often quoted in terms of YTM. l The U.S. Treasury Yield Curve is the benchmark for the credit market, because it represents the yields of risk-free fixed income investments across a range of maturities. l Typically, the Treasury yield curve is upward-sloping (longer- term investments require higher yields). Fin330 29
Image of page 29

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

U.S. Treasury Yield Curve Fin330 30 Source:
Image of page 30
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern