## Bonds and Their Valuation

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Bonds and Their Valuation

WHAT IS BOND?

A longterm debt instrument in which aborrower agrees to make payments ofprincipal and interest, on specific dates, tothe holders of the bond.

BOND YIELDS

Yield to Maturity

the rate of return earned on a bond if it is heldto maturity

Yield to Call

the rate of return earned on a bond when it iscalled before its maturity date.

-->Sells at Premium

In general, if a bond sells at a premium, then

1) coupon --> rd

2) a call is more likely

--> Sells at Discount

Expected to Earned

YTC on premium bond

YTM on par and discount bonds

BOND VALUATION

(Par Bond)

rd = coupon rate, fixedrate bond sells at par

(Discount Bond)

rd --> coupon rate, fixedrate bond sells belowpar

(Premium Bond)

rd > coupon rate, fixedrate bond sells abovepar

CHANGES IN BOND VALUES OVER TIME

At maturity, the value of any bond must equalits par value.

current yield (CY)= Annual Coupon Payment / Current Payment

Capital Gains Yield(CGY) = Change in Price / Beginning Price

Expected Total Return = YTM = (Expected CY) + ( Expected CGY)

BOND FEATURES

Par Value the facevalue of abond

Coupon Interest Rate the specifiednumber of dollars ofinterest paid eachyear

Maturity Date a specified dateon which the parvalue of a bondmust be repaid.

Issue date – when the bond was issued.

Yield to maturity (YTM) rate of return earnedon a bond held until maturity (also called the“promised yield”).

Yield to call (YTC) rate of return earned on abond when it is called before its maturity date.

Call Provision a provision in a bond contractthat gives the issuer a right o redeem thebonds under specified terms prior to thenormal maturity date.

SEMI-ANNUAL BOND

STEPS :)

1) Multiply years by 2 : number of periods = 2n.

2) Divide nominal rate by 2 : periodic rate (I/YR) = rd / 2.

3) Divide annual coupon by 2 : PMT = ann cpn / 2.

Annual VS Semiannual

(Semiannual effective rate) --> (the annualbond’s effective rate)

so you would preferthe semiannual bond.