Bonds and Their Valuation

Bonds and Their Valuation
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 annual
bond’s effective rate)
so you would prefer
the semiannual bond.
WHAT IS BOND?
A longterm debt instrument in which a
borrower agrees to make payments of
principal and interest, on specific dates, to
the holders of the bond.
CHANGES IN BOND VALUES OVER TIME
At maturity, the value of any bond must equal
its 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 face
value of a
bond
Coupon Interest Rate
the specified
number of dollars of
interest paid each
year
Maturity Date
a specified date
on which the par
value of a bond
must be repaid.
Issue date – when the bond was issued.
Yield to maturity (YTM) rate of return earned
on a bond held until maturity (also called the
“promised yield”).
Yield to call (YTC) rate of return earned on a
bond when it is called before its maturity date.
Call Provision a provision in a bond contract
that gives the issuer a right o redeem the
bonds under specified terms prior to the
normal maturity date.
BOND YIELDS
Yield to Maturity
the rate of return earned on a bond if it is held
to maturity
Yield to Call
the rate of return earned on a bond when it is
called 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 below
par
(Premium Bond)
rd > coupon rate, fixedrate bond sells above
par
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